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September 2011 The Covered Bond Report 1

CONTENTS

FROM THE EDITOR

3 Thanks, but no thanks

MONITOR

4 Legislation & regulation

12 Ratings

17 Market

21 League Tables

26

20

8

Cover StoryRATING AGENCIES

26 Raters feel the heat

Neil Day


2 The Covered Bond Report September 2011


32

Q&A: PHILIPP WALDSTEIN

22 UniCredit: more than covered

Neil Day

NORWAY: SAFE HAVEN

32 Northern light

Susanna Rust

EMERGING MARKET: TURKEY

40 SMEs bridge Turkish gap

Maiya Keidan

ANALYSE THIS:

44 Has the market got Denmark wrong?

44

40

CONTENTS

FROM THE EDITOR


Guarantees for covered bonds? We’ve

heard this one before.

Morgan Stanley bank analyst Huw

van Steenis did, however, bring a new

twist to the proposal with a widely

discussed paper in mid-August: that

guarantees come not from individual sovereigns but

from the European Financial Stability Facility (EFSF).

Van Steenis sensibly suggests that were the EFSF to

go about guaranteeing bank debt, covered bonds might

be more politically acceptable given that economic risks

could be reduced.

As with all good things in the covered bond market,

the idea of governmental guarantees brings to mind a

German expression: doppelt gemoppelt. Covered bonds

are already guaranteed — effectively senior bank debt

with a guarantee from the cover pool.

For proponents of covered bonds, any sovereign or su-

pranational guarantees would be a retrograde step.

In the wake of the collapse of Lehman Brothers Eu-

ropean countries set up schemes for their banks to issue

government guaranteed debt. Only in Sweden was the

standard template pioneered by the UK extended to in-

clude covered bonds, but no one used the facility.

True, it took European Central Bank support to help

the market to its feet with a covered bond purchase pro-

gramme after senior debt had already started flowing. But

since this prop was removed last year the asset class has

surpassed expectations.

This is partly thanks to regulatory initiatives such as Ba-

sel III supporting covered bonds and bail-in fears hitting

senior unsecured levels, but the fundamental strengths of

covered bonds have been key to the asset class’s success.

Witness a Eu1bn 10 year UniCredit obbligazioni bancarie

garantite issue backed by Italian residential mortgages at

the end of August, which was priced flat to an Italian gov-

ernment bond curve being supported by the ECB.

Guaranteeing covered bonds would also have the per-

verse effect of weakening the arguments of those lobby-

ing in favour of the asset class around the world, not least

in the US, where the merest whiff of taxpayers’ money

being necessary is used as a counter-argument. Turning

to guarantees could also lessen the impact of their im-

pressive performance in Europe, where covered bonds

have been a rare source of encouragement.

Regulators, politicians and others would do better

to focus on the root causes of the crisis. Covered bonds

alone won’t save the world. But guarantees could prevent

them from playing their full role in the recovery.

Neil Day, Managing Editor

Thanks, but no thanks

The CoveredBond Reportwww.coveredbondreport.com

EditorialManaging Editor Neil Day

+44 20 7415 [email protected]

Deputy Editor Susanna [email protected]

Reporter Maiya [email protected]

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MONITOR: LEGISLATION & REGULATION

Disclosure on an electronic platform as

envisaged in a transparency initiative by

the ICMA Covered Bond Investor Coun-

cil is of “utmost importance”, according

to the ECB, which said that the CBIC’s

work should help inform industry eff orts

to establish a covered bond label.

Th e European Central Bank’s com-

ments were made in a response to a con-

sultation on the CBIC’s proposed trans-

parency standards and were just one of

several to emphasise a need for greater

clarity and standardisation of defi nitions

and concepts included in the CBIC’s tem-

plate. Francesco Papadia, director gener-

al of market operations at the ECB, said

that this was important to help foster the

objectives of a better functioning market

and greater integration.

Th e ECB’s feedback also pointed to a

need for a balance to be struck between

providing “comparable, timely, frequent

and easy to access data” and limiting is-

suers’ administrative burden.

“Th e electronic platform accessible

to all (investors, issuers, rating agencies,

market analysts, academics, and com-

mercial data providers) envisaged in the

CBIC’s consultation paper is therefore of

utmost importance,” said Papadia.

He referred to the commercial paper

market’s Short Term Paper Market in Eu-

rope (STEP) project and a recent ABS loan

level data initiative, saying that the ECB

would be pleased to share its experience “on

a catalytic basis”. Th e Covered Bond Report

understands that the STEP project is being

looked at as an example of a successful label-

ling initiative by the ECBC, which is leading

the covered bond market’s eff orts.

“Against this background,” said Papa-

dia, “I would regard it useful if the CBIC

and the ECBC would join forces both

from a conceptual and a technical point

of view in order to achieve and maintain

a meaningful transparency pillar of the

prospective covered bond label.”

In its response to the CBIC consulta-

tion the ECBC described the introduc-

tion of a label for covered bonds as its

main focus, adding that transparency

will form a key element of the label.

“Th e label transparency component

is the result of a detailed ongoing refl ec-

tion conducted by the ECBC that was

launched in late 2009,” it said.

Nathalie Aubry-Stacey, director, regu-

latory policy and market practice at the

International Capital Market Associa-

tion, told Th e Covered Bond Report that

half a dozen investors responded to the

CBIC’s consultation “in addition to many

investor comments received as the tem-

plate was draft ed”.

“We will be publishing a reviewed

template in September/October and look

forward to working with the ECBC and

national associations,” she said.

Th e only buy-side feedback published

on the CBIC’s website was from Pioneer

Investments, whose letter assessed the

data in the template thus: “Pretty exten-

sive and should cover most of the infor-

mation requirements.”

However, 12 investors are named on

the CBIC’s website as “supporting en-

hanced transparency standards in the

European Covered bond market”, includ-

ing Allianz GI, Generali Investments, Le-

gal & General, and Schroders.

Th e UK Financial Services Authority,

HM Treasury and Bank of England said that

the CBIC’s transparency template should

extend to require loan-level data in addi-

tion to the stratifi cation tables proposed.

However, the UK Regulated Covered Bond

Council (RCBC) set out a preference — in

line with the CBIC’s — for aggregate cover

pool rather than loan-level data.

Th e UK RCBC listed several ways in

which it felt the CBIC’s template could be

improved, for example by better defi ning

or describing certain requirements re-

ferred to in the proposed standards.

“In the absence of clarifi cation, the

goal of establishing a consistent and har-

monised standard will not be achieved as

issuers may report certain information

on a diff erent basis,” it said.

Th e UK RCBC also drew attention

to the existence of other covered bond

transparency initiatives put forward by

diff erent industry organisations and dif-

ferent regulators, calling for a joint ap-

proach to be adopted where possible.

“In general, we consider that further

work may be required in order to es-

tablish a suitable benchmark for all, to

avoid certain potential unintended con-

sequences and to strike an appropriate

balance from a cost-benefi t perspective,”

it said. “Th is work should not be rushed

and the fi nal product should allow fl exi-

bility for further market development.”

ICMA

ECB hails CBIC transparency push

ECB calls for CBIC and ECBC to join forces

“The fi nal product should allow

fl exibility”

Legislation & Regulation



Australian covered bond legislation

could be in place by Christmas, accord-

ing to a Treasury offi cial, laying the foun-

dations for the fi rst issuance from the

country in 2012.

Speaking at a conference in mid-August,

John Lonsdale, general manager, fi nan-

cial system division, markets group, at the

Treasury, said that the department is work-

ing towards giving Treasurer (and deputy

prime minister) Wayne Swan the option of

introducing a bill into parliament early in

the Spring session, which started in August.

Th at could allow passage of the bill

by the time the session ends in late No-

vember, with Royal Assent being given

by Christmas. Lonsdale said that alterna-

tively the legislation would probably be

passed in early 2012, aft er which it would

be up to industry to progress.

Lonsdale said that the Australian Pru-

dential Regulation Authority (APRA)

will revise some of its prudential stand-

ards to facilitate covered bond issuance

and that he expects the regulator to con-

sult on these in the coming months.

Th e Treasury released proposals for

covered bond legislation in March and the

subsequent consultation fi nished in April.

Lonsdale said that while “the devil is in

the detail” when it comes to such legisla-

tion, he could not discuss the fi nal wording

of the bill that will be introduced to parlia-

ment. He nevertheless gave some insights

into the Australian government’s thinking.

“Although the draft legislation attempts

to obtain international best practice, it

does not simply replicate the European

framework, which in general is highly pre-

scriptive, and is adapted for the Australian

context,” said Lonsdale. “One benefi t of the

diversity in off shore jurisdictions is that we

can observe how these frameworks operate

in practice, allowing us to pick and choose

those features that seem to work best.”

Crisis lessons heededLonsdale said that the issue of asset en-

cumbrance that comes with covered

bond issuance and how this aff ects unse-

cured creditors had come to the fore in

light of the fi nancial crisis.

“Th e proposed legislative cap of 8%

on covered bond issuance by ADIs seeks

to address any asset encumbrance con-

cerns, while also meeting regulatory

best practice,” he said. “As well as look-

ing at off shore best practice, we have lis-

tened closely to the views of stakehold-

ers on how the new Australian legislative

framework should be designed.”

He said that, alongside the introduc-

tion of a permanent fi nancial claims

scheme, measures proposed under the

legislation would maintain depositor

protection even if the introduction of

covered bonds might breach the previous

“depositor preference” concept hitherto

enshrined in the Banking Act.

Lonsdale expanded upon APRA’s over-

sight of covered bonds under the proposed

legislation, saying that it will have the power

to prevent authorised deposit-taking insti-

tutions (ADIs) from issuing or topping up

covered bonds under certain circumstances,

“such as the ADI experiencing severe fi nan-

cial stress or breaching the requirements of

the Banking Act 1959”. However, he noted

that APRA has no power over assets provid-

ing security to covered bondholders once

they have been transferred to a cover pool.

Expectations of pooled covered bond

issuance from smaller Australian fi nancial

institutions were dampened by Lonsdale

when he said that “an aggregation model is

not likely to be used in the period imme-

diately aft er the covered bond bill becomes

law”. However, he said that the possibility

of aggregation models should provide op-

portunities in the medium to longer term.

“Th e government is interested in pro-

viding a mechanism to allow smaller

ADIs to issue covered bonds into the

Australian market in particular,” he said.

Lonsdale said that during the consul-

tation process investors had requested

regulatory disclosure requirements for

covered bonds, and that he expects the

Australian Securitisation Forum to work

to develop such a framework, similar to

one developed for residential mortgage

backed securities (RMBS).

AUSTRALIA

Aussie law could be done by Christmas

“We have listened closely to the views of

stakeholders”

Parliament could see bill in spring session

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FEBELFIN

Belgian pandbrieven come into view

Belgian bankers are waiting for the coun-

try’s central bank to release a draft cov-

ered bond law that, according to Dexia

analysts, could be in place by year-end.

Concrete discussions about a frame-

work have been taking place between

Belgian banks, the National Bank of Bel-

gium (NBB), the Belgian fi nancial super-

visory authority (FSMA), and law fi rms

since at least 2009.

“Belgium is currently one of the few

European countries that has no dedicat-

ed legal framework in place,” said Dexia’s

analysts. “However, it should not take

too long anymore before Belgian credit

institutions can use covered bonds as an

alternative funding tool knowing that

the covered bond fundamentals are laid

down in a draft legislation.”

Th e country’s banks will then be able

to issue bonds designated “pandbrieven”

or “lettres de gage” in the draft .

Th e country’s banks have submitted

— via a working group operating under

the auspices of the Belgian banking as-

sociation (Febelfi n) — comments on the

draft to NBB, which has yet to return a

reviewed version to the working group.

“Th ere is no confi rmed timeline, but

the central bank had indicated that it

would probably not revert before the end

of the summer,” said an offi cial at one

Belgian bank. “We hope that it will revert

by late August/early September.”

Th e Covered Bond Report under-

stands that in its feedback the Febelfi n

working group suggested only minor

changes to the proposed law, on which

there is general agreement.

Once the NBB gets back to the banks

with a reviewed version of the law it will

be sent to the fi nance ministry and the

European Central Bank, and thereaft er

to Belgium’s parliament. Th e supreme ad-

ministrative court (Conseil d’État/Raad

van State) will also need to pass judge-

ment on the law.

Sounds like Pfandbrief?In its prevailing form, which Dexia’s ana-

lysts noted may change, the draft frame-

work provides for a structure based on

issuance by universal credit institutions

that will need to be licensed as covered

bond banks by the NBB, as will be the

case for individual programmes, too.

A cap on issuance does not appear to

have been set, with Dexia’s analysts only

referring to the possibility that the NBB

might decide a limit on a case-by-case

basis. An offi cial at one of the Belgian

banks confi rmed that the NBB would

have full discretion in this context.

Th e draft law also provides for the

segregation of assets into two separate

estates for covered bond issuers, with a

general one containing assets of the is-

suer to which all creditors have direct

recourse, and a segregated estate com-

prising the cover pool. Any initiation of

insolvency proceeding will not aff ect the

assets recorded in the segregated legal es-

tate, according to the Dexia analysts.

Th ey noted that the draft law is inspired

by the German Pfandbrief Act, with com-

mon elements including direct issuance

from the balance sheet, a cover asset regis-

ter, a 180 day liquidity rule, and a separate

programme for diff erent asset classes.

However, in contrast to the Pfandbrief

Act, the draft Belgian legislation accepts

securitisations as cover pool assets under

certain conditions, such as 90% of the pool

underlying the securitisation being directly

eligible for covered bonds and originated

by a group-related entity of the issuer.

In addition, while Germany’s Pfand-

brief banks do not have to set up sepa-

rate programmes for commercial and

residential mortgages, the draft Belgian

legislation foresees this being the case for

Belgian banks.

Another aspect of the draft legislation

highlighted by Dexia’s analysts is that it pro-

vides for covered bonds being compliant

with Ucits 52 (4) and the Capital Require-

ments Directive. However, they note that a

distinction is made at programme level be-

tween CRD-compliant covered bonds, i.e.

Belgian pandbrieven/lettres de gage, and

non CRD-compliant covered bonds, sim-

ply called Belgian covered bonds.

“Th e denomination of both terms

[pandbrieven/lettres de gage and cov-

ered bonds] is protected by law,” said the

analysts. “Th ese distinct types of covered

bonds will appear on two separate lists.

However the way that the law and the

Royal Decree are stipulated, assures that

in practice the Belgian credit institutions

will only be able to issue CRD-compliant

covered bonds.”

Statue in grounds of National Bank – movement awaited



LATIN AMERICA

Banks lobby for Brazilian LFIsTh e Brazilian Association of Real Estate

Loans & Savings Companies (Abecip)

in late July presented a proposal to the

country’s central bank for a Brazilian ver-

sion of covered bonds, in a bid to create

a long term funding instrument that can

support a fast growing real estate fi nanc-

ing market, according to Moody’s.

Savings deposits have been the prima-

ry source of mortgage fi nancing in Brazil,

with the country’s banks mandated to in-

vest at least 65% of these into real estate

lending, but this funding source is dwin-

dling and “could soon constrain further

expansion of mortgage fi nancing”, said

the rating agency.

Moody’s said that the introduction

of Brazilian covered bonds, to be called

Letras Financeira Imobiliarias (LFI), is

a credit positive for the country’s banks

because it provides for an alternative long

term funding instrument that will allow

Brazilian banks to serve growing housing

demand.

LFIs are structured as debt securi-

ties that will be guaranteed by the issu-

ing banks and a pool of assets. Th e rat-

ing agency said that the proposed format

calls for tax exemption on investments

in longer maturity papers, primary those

with fi ve to 10 year tenors, aimed at cre-

ating additional incentives for investors.

Moody’s noted that the country’s

banks have no incentive to securitise

their mortgage portfolios because they

are required to invest in real estate, there-

fore making that funding source unat-

tractive.

Mortgage loans have been growing

at an annual average rate of 45% since

2007 — in contrast to an 18% increase

in savings deposits, with Brazil’s largest

banks standing to benefi t the most from

the introduction of covered bonds, said

Moody’s. Th ese are: Banco Santander

(Brasil), Banco Bradesco, Itaú Unibanco,

and Banco do Brasil. Caixa Economica

Federal, with a 60% market share, is

the largest player in this market, said

Moody’s.

FSA

Encumbrance on new UK Forum agendaThe UK Financial Services Authority is working on updating its asset encum-brance policy, according to the minutes of the fi rst meeting of a new body, the UK Covered Bond Forum

A review of the UK Regulated Covered Bond framework, transparency stand-ards, and ratings were also discussed at the fi rst forum, which took place in June, according to recently released minutes.

The FSA was asked for an update on asset encumbrance policy – a topic that has come to the fore in the wake of the fi nancial crisis and that has been debated in countries that are introducing covered bond legislation, such as Australia.

According to the minutes, Lara Joseph of the FSA’s capital markets team “ex-plained that a survey has been sent out to

fi rms by the FSA, and work is ongoing to update policy in this area”.

Suggestions for future topics of discus-sion included the implications of Solvency II, CRD IV and retail ring-fencing propos-als being developed by the Commission for Banking, which is reviewing the UK banking industry.

The new body takes on a role previ-ously played by the FSA’s Covered Bond Standing Group (CBSG), which broke up as issuance of covered bonds in the pub-lic markets dried up after the onset of the fi nancial crisis.

John Wu, senior associate, capital markets team at the FSA, told The Cov-ered Bond Report that the UK Covered Bond Forum has a similar mission to that of the CBSG in that it is meant to be a group where market participants can air their views on market developments and regulations. The FSA intends for the forum to meet at least twice a year.

“It should be frequently enough so that there is a continuous dialogue, but with suffi cient time in between for there to be substantial issues to discuss,” said Wu.

The forum differs from the standing group in that the membership is broader, extending to investors and trade associa-tions, according to Wu, while the CBSG only comprised the tripartite authorities and issuers.

“Work is ongoing to update policy in this

area”

Banco Central do Brasil: received Abecip proposal

“Changes have clarifi ed a few issues thatwere not in the original legislation” page 42



ASIA

Japanese law planned with a public faceA push for covered bond legislation in Ja-

pan has been spurred in part by a desire

to keep up with developments elsewhere,

but its goal contrasts with that of many

other countries, according to a banker

familiar with the initiative.

Japan has yet to join the ranks of cov-

ered bond jurisdictions, with Shinsei

Bank having in 2008 aborted a struc-

tured, mortgage backed deal on account

of the fi nancial crisis and no issuance

having been attempted since.

Th e government-owned Development

Bank of Japan (DBJ) is now spearhead-

ing a push for covered bond legislation

in Japan. It is leading a study group that

on 7 July published a report setting out

a range of considerations raised by its

members — representatives from major

banks, securities fi rms, rating agencies

and the Bank of Japan; academics, law-

yers, and institutional investors.

Yukio Egawa, chief strategist, head of

research division at Shinsei Securities in

Tokyo and a member of the study group,

told Th e Covered Bond Report that cov-

ered bond legislation has only recently

become the focus of market participants’

eff orts, and that DBJ has been leading the

initiative as it considers ways to diversify

its funding sources.

“Another reason for the timing of

these eff orts is the spreading of covered

bond legal frameworks across the world,

including in Australia, Canada, Korea

and other non-European nations,” he

said. “If the trend continues and we do

not introduce our own framework then

Japanese institutions will be at a disad-

vantage from a competitive viewpoint

compared with European and North

American institutions.”

But while developments in new juris-

dictions have tended towards mortgage

fi nance, Japanese market participants are

eyeing the asset class in the fi rst instance

primarily as a tool to raise medium to

long term funding for public fi nance, pri-

vate fi nance initiative (PFI), social infra-

structure and industrial lending.

“It is very unlikely that covered bonds

will be used for housing fi nance (residen-

tial mortgages) for the time being,” said

Egawa. “Public fi nance, PFI, loans to rail-

way and other infrastructures are more

likely to form cover pool collateral.”

He identifi ed two reasons for the pub-

lic sector focus: as the main driver be-

hind the initiative, DBJ, does not lend to

consumers; and fi nancing of residential

mortgages in Japan is generally well pro-

vided for by the Japan Housing Finance

Agency, which purchases fi xed rate mort-

gages from originators and securitises

them.

Breadth could infl uence timingAccording to Egawa, covered bond pro-

ponents are aiming for legislation to be

introduced within the fi rst half of next

year, and that the fi rst issuance – initially

domestic – would also take place in 2012.

Th e ease, or otherwise, with which

legislation might receive political ap-

proval could depend on the scope of the

proposed framework and how it can be

squared with concerns about structural

subordination.

“If the legislation limits the number of

eligible issuers, in an extreme case only

to DBJ or to DBJ plus the three largest

private banks, then it may not be that

diffi cult to pass legislation,” said Egawa.

“But if we try to expand the scope of the

law it may take more time and eff ort to

persuade the banking regulators.”

According to Egawa the study group

has already envisaged ways in which cov-

ered bond issuance could be structured

to avoid a confl ict with Japan’s existing

bankruptcy laws, under which deposit

taking banks can be placed under legal

bankruptcy procedures.

Also under discussion are the maturi-

ties the study group envisages the fi rst Jap-

anese covered bonds could feature, which,

at 10 years or longer, would be quite dif-

ferent from the average tenor of recent

dollar and euro benchmark supply.

“Th e terms of social infrastructure,

PFI and local government loans, which

we are looking at covered bonds fi nanc-

ing, tend to have very long maturities, of

20 years or more,” said Egawa. “In addi-

tion both private sector banks and DBJ

have been able to raise funding of up to

10 years at very tight credit spreads in the

unsecured market.”

It is not clear what the next steps are

aft er the study group published its re-

port in July. Egawa said that the group

is agreed on the need for a legal frame-

work and standardisation, but that many

points are still open as various alterna-

tives are pursued.

Yukio Egawa, Shinsei: Covered bonds unlikely to be used for housing fi nance

“Public sector loans tend to have very long maturities”


Did you know that The Covered Bond Report has its own database of benchmarks?

Did you know that we link directly from bond data to relevant coverage?

Did you know that we include price guidance, book sizes and distribution statistics?

Did you know that you can run league tables by country and currency?

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The Covered Bond Report is not only a magazine, but also a website providing news, analysis and data on the market.


MONITOR: RATINGS

Standard & Poor’s downgraded 46 multi-

cédulas between one and nine notches on

1 August, surprising market participants

by the severity of its actions, with ana-

lysts disagreeing with the rating agency’s

view on concentration risk in particular.

The rating agency removed the multi-

cédulas, totalling some Eu103bn, from

CreditWatch negative. They were put on

review in September 2010. Only two is-

sues that were subject to the review re-

tained their AAA ratings.

“People are surprised that we saw as

much as a nine notch downgrade,” said

Frank Will, senior analyst at RBS. “I did

not expect a downgrade to BBB- of some

of the transactions. I thought maybe we’d

see a downgrade to single-A, but not so

close to junk.

“It’s clear that there is something

wrong with S&P’s approach if you have

downgrades of this extreme.”

Two transactions, for example an AyT

Cédulas deal launched in March 2007,

fell to BBB-.

“It was issued based on our perfect

world environment we had back then,”

said Florian Hillenbrand, senior analyst

at UniCredit. “Going from as high as

AAA to BBB- is tough, but rating agen-

cies tend to do tough calls these days

and S&P usually comes around with the

toughest calls since they base their as-

sessments on Probability of Default rath-

er than on expected loss.”

S&P cited deterioration in the credit

quality of the financial institutions be-

hind the multi-cédulas between 2008 and

2011 as the main reason for the down-

grades. In 2008 71.93% of issuers were

rated higher than bbb/BBB (credit esti-

mate or rating), but by 2011 the number

in that category had dropped to 27.27%

(see table below for more details).

Along with an amplified credit risk,

the rating agency said a consolidation

within the Spanish savings banks sector

had heightened concentration risk of the

multi-cédulas and increased the impact

of an individual financial institution on

the corresponding multi-cédulas.

Analysts found fault with this reason-

ing, saying the merger of banks that had

occurred in Spain had likely done more

good than harm.

“They didn’t take into account the me-

dium to long term benefits of the merg-

ers,” said Will at RBS. “I can’t understand

the reasoning behind S&P’s views.”

Dries Janssens, fixed income strategist

at Dexia Capital Markets, agreed that the

merger of the institutions was more likely

to have enhanced credit quality than neg-

atively affected it.

“The S&P report seems to put more

emphasis on the deterioration of the

creditworthiness of the cajas, than on the

positive effects of consolidation and re-

capitalisation,” he said.

Will added that S&P had not taken

into account the “massive” overcollater-

alisation levels on the multi-cédulas.

The rating actions also came as a re-

sult of the adoption of an updated ver-

sion of S&P’s credit risk model, which

addresses updated default rate stresses,

correlation assumptions, concentration

risks, and model risk.

S&P said the credit enhancement to

cover possible interest shortfalls in 46 of

the 48 transactions analysed “would not

be sufficient to pay interest on all bonds

to a AAA rating level if a cédulas de-

faults”.

SPAIN

Severe S&P multi-cédulas cuts criticised

“S&P usually comes around with the toughest calls”

“Consolidation has heightened

concentration risk”

Ratings

CHANGE IN CREDIT QUALITY OF MULTI-CÉDULAS PARTICIPANTS 2008-2011

2008 2011

Credit estimate/rating % of entities Number of entities % of entities Number of entities

aa-/AA- or higher 7.02 4 11.36 5

a+/A+ 12.28 7 0 0

a/A 15.79 9 6.82 3

a-/A- 14.04 8 6.82 3

bbb+/BBB+ 22.81 13 2.27 1

bbb/BBB 17.54 10 18.18 8

bbb-/BBB- 1.75 1 36.36 16

bb+/BB+ or lower 8.77 5 18.18 8

Total 57 44

Source: Standard & Poor’s


MONITOR: RATINGS

ECB REPO

Greeks tweak to avoid Fitch junkingGreek banks have restructured their

covered bond programmes in success-

ful bids to stave off downgrades below

investment grade by Fitch, keen to keep

investment grade ratings necessary for

continued repo eligibility with the Euro-

pean Central Bank.

Greek banks have had to take action as

their issuer ratings faced pressure in spite

of the second rescue package for their

sovereign, and particularly with Moody’s

having already stripped their covered

bonds of investment grade ratings.

At the end of July Fitch confi rmed that

structural changes have been made to

covered bond programmes of four Greek

banks that it had said were necessary to

avoid downgrades.

Th e BBB- ratings of the four pro-

grammes were left on Rating Watch

Negative. Th e rating agency said that its

continuing review “refl ects the adverse

economic conditions and heightened

uncertainty surrounding recent develop-

ments in Greece”, and the RWN status of

the four banks’ issuer ratings.

Alpha Bank, Eurobank EFG, National

Bank of Greece and Piraeus Bank com-

pleted structural adjustments to trans-

form the liability profi les of covered

bond programmes in line with a release

by Fitch on 14 July, which had said that

the changes were expected by 29 July and

that the ratings would be cut were the

restructurings not implemented by then.

NBG’s changes are to its Programme II.

Fitch said structural amendments to

the four covered bond programmes have

changed their liability profi le from soft

bullet redemption to partial pass through

amortisation. Th e rating agency said that

this transformation mitigates refi nancing

risk aft er an issuer default by eliminating

maturity mismatches between the cover

assets and the covered bonds.

Th e issuers have revised their pro-

grammes so that the maximum Asset

Percentage commitment is contractually

undertaken. Fitch said a contractual As-

set Percentage clause off ers more protec-

tion to bondholders than a public com-

mitment and was a credit positive for the

covered bonds.

Fitch added that it expected Greek is-

suers to demonstrate an ability to replen-

ish their cover pools on a regular basis by

maintaining assets over and above the vol-

ume of assets required to meet their con-

tractual Asset Percentage commitments.

COLLATERAL ANALYSIS

Moody’s covered-RMBS checks differMoody’s relies far less on double-checking of loan-by-loan data for covered bonds than for residential mortgage backed securities given the on-balance sheet nature of cov-ered bonds and the lower importance of col-lateral analysis as a factor when rating them.

In an August report, “Identifying key aspects of pool AUP reports in EMEA struc-tured fi nance and covered bond transac-tions”, the rating agency discussed how it ensures the integrity of data through reports provided by originators and arrangers.

“Third parties usually conduct these data checks on a sample of the underlying asset pool and in compliance with agreed-upon procedures (AUP),” said Moody’s.

The AUP reports assess the integrity of loan-by-loan data provided by originators.

The rating agency said that as loan-by-loan data is the basis for its analysis of

the credit quality of portfolios underlying RMBS, “the accuracy and veracity of the information relating to the main risk driv-ers is vital”. It therefore expects independ-ent third parties to have assessed factual information provided by issuers and their agents that is key to determining ratings.

But Moody’s said that it does not rou-tinely receive pool AUP reports for cov-ered bond transactions. It cited two rea-sons for this; fi rstly, the on-balance sheet nature of covered bonds.

“In covered bond transactions, the loans that secure the covered bonds are normally originated by the issuer group and remain on the issuer’s balance sheet,” said the rating agency. “The expectation is that issuers, as regulated and supervised fi nancial institutions, will maintain high standards of quality control over all their

loan operations, regardless of whether the loans are in the cover pool or not.”

The second reason relates to the im-portance of factors aside from collateral quality in Moody’s covered bond rating methodology.

“The amount of losses we model for covered bond transactions are only partly (currently about one-third) derived from the collateral analysis,” said the rating agency. “The remainder are due to market risks that arise due to refi nancing risk and interest rate and currency mismatches.”

Moody’s said that it would not expect a pool AUP report to have a “material” impact on its analysis of the majority of covered bond transactions. However, it said that it may consider AUP reports in certain cases and if the issuer is lowly rated or unregulated.

Greeks under pressure

“Norway’s economy is moresheltered from abroad” page 34


MONITOR: RATINGS

FITCH

Downgrade rate doubles on sovereign woesFitch downgraded as many covered bond

programmes in the first half of the year as

it did in all of 2010, reflecting the damage

the euro-zone debt crisis has caused the

asset class.

The 33 downgrades made by Fitch

were confined to Portuguese, Greek,

Spanish, Irish and Cypriot financial insti-

tutions or their affiliates, said the rating

agency in an EMEA structured finance

snapshot report released in early April.

“The vast majority resulted from sov-

ereign rating downgrades and/or down-

grades of the relevant issuer default rat-

ings,” said Hélène Heberlein, managing

director of covered bonds at Fitch. “In

fewer cases, the decision was motivated

by insufficient overcollateralisation, li-

quidity and comingling issues.”

And she said that the unfolding sov-

ereign crisis is obstructing access to the

capital markets for covered bonds from

those countries affected.

However, the doubling in the rate of

downgrades did not stop covered bonds

from achieving a record breaking year, hit-

ting Eu215bn of new issuance in the first

half of 2011, according to the rating agency.

Heberlein highlighted the attractions

for issuers and investors that have been

driving the supply surge.

“A competitive cost of funding would

certainly be the first argument cited by

bank treasurers,” she said. “Although cov-

ered bond spreads rose substantially since

the onset of the global financial crisis, they

were on average subject to lower spikes

than those witnessed in the senior unse-

cured debt and securitisation markets.

“On the other hand, investors’ appe-

tite is fuelled by risk aversion and regu-

latory incentives. Historically, legislative

covered bonds have attracted a low capi-

tal charge at EU investing banks. Also

preferential eligibility criteria as well as

haircuts have been applied for central

bank repo operations. Additionally, some

covered bonds qualify for banks’ future

mandatory liquidity coverage ratios, and

the debt instrument is widely expected

to be exempted from banks resolution

regimes.”

She added that the rest of the year could

be quieter given that some issuers took ad-

vantage of the buoyant first half to meet

their funding needs “to a large extent”.

Regulation de rigueurFitch highlighted a trend towards cov-

ered bonds based upon dedicated legisla-

tive frameworks rather than contractual

issuance, noting that whereas two-thirds

of the programmes it rated were legisla-

tive based in 2009, three-quarters are

today. Among developments contribut-

ing to this was the introduction of ob-

ligations de financement de l’habitat in

France in March.

The rating agency noted that Canada

and New Zealand, where issuance is al-

ready established on a contractual basis,

have launched consultations regarding

introducing legislative frameworks — but

that in some of these younger jurisdic-

tions regulators were also looking more

closely at the wider impact of covered

bond issuance. Fitch pointed out that the

Reserve Bank of New Zealand has set a

10% limit on the amount of assets that

can be encumbered by covered bond is-

suance, while Canada’s Department of

Finance has proposed a maximum over-

collateralisation level of 10%.

But while Heberlein noted further de-

velopments in Australia, for example, she

was cautious about prospects in the US.

“Disagreement between stakeholders

persists on the allocation of overcollater-

alisation in the event of an issuer default,”

she said.

The Federal Deposit Insurance Cor-

poration continues to have objections to

an initiative to introduce covered bonds

by Republican Congressman Scott Gar-

rett, who nevertheless saw the United

States Covered Bond Act of 2011 passed

by the House Financial Services Com-

mittee in June.

“Disagreement persists on

allocation of overcollateralisation”

01020304050

Fran

ce

Ger

man

y

Spai

n

Uni

ted

King

dom

Italy

Swed

en

Nor

way

Net

her-

land

s

Finl

and

Can

ada

Switz

erla

nd

Aus

tria

Eu (bn)

Top 12 countries by covered bond issuance H1 2011

Source: Fitch, Dealogic


MONITOR: RATINGS

Fitch cut the rating of mortgage covered

bonds issued off a former Washington

Mutual programme to one notch above

the rating of the programme sponsor, JP

Morgan Chase Bank, because of a dete-

rioration in collateral quality.

The rating agency downgraded the

covered bonds at the beginning of Au-

gust from AA+ to AA, one notch above a

AA- long term issuer default rating of the

sponsor bank.

“The rating downgrade is driven by

increased loss expectations assessed on

the cover pool assets on account of the

deterioration in observed performance

of US payment-option and interest-only

hybrid adjustable rate mortgages,” said

Fitch. “As a result, the level of overcollat-

eralisation in the programme is no longer

sufficient to provide expected recoveries

above 91% on defaulted covered bonds in

an AA+ stress scenario.”

In addition to the rating of JP Morgan

Chase, the rating of the covered bonds

is based on a Discontinuity Factor (D-

Factor) of 100%, which captures Fitch’s

assessment that the bonds’ probability of

default is aligned with that of the sponsor

bank. However, Fitch said that a contrac-

tual maximum asset percentage (AP) of

67% is commensurate with a AA stress

scenario on a recovery basis.

The rating agency has assigned the

100% D-Factor to the WM Covered Bond

Program because it believes that potential

asset and liability mismatches after an is-

suer default cannot be bridged. This is

because as an institution insured by the

Federal Deposit Insurance (FDIC) Act, JP

Morgan Chase is subject to a 90 day auto-

matic stay period upon insolvency, while

two of three outstanding series of soft bul-

let covered bonds issued off the programme

only provide for an extension period of 60

days. This does not give the mortgage bond

indenture trustee sufficient time to enforce

its security over the cover pool and liqui-

date the portfolio prior to covered bond

redemption, said Fitch.

US

WaMu covered fall on collateral deterioration

HM TREASURY

UK misfits shrug off guarantee differencesCovered bonds issued by the government owned rumps of Bradford & Bingley and Northern Rock have been affirmed at AAA by Fitch, in spite of the rating agen-cy taking different attitudes to govern-ment support for the programmes, while Standard & Poor’s upped B&B’s to AAA.

Fitch in mid-August affirmed covered bonds issued by Northern Rock Asset

Management at AAA, although — un-like a Bradford & Bingley affirmation two weeks earlier — it gave no credit to an HM Treasury guarantee because of differences between the two support arrangements.

Fitch said that it does not give credit to the guarantee provided to NRAM’s cov-ered bonds because it can be removed with at least three months’ notice.

“The agency is not comfortable giv-ing credit to a short term guarantee to support its long term rating on the cov-ered bonds as it does not consider there is sufficient protection to support the covered bond rating upon withdrawal of the guarantee,” it said.

Fitch had in late July affirmed at AAA covered bonds issued by Bradford & Bin-gley based on an HM Treasury guaran-tee, even though the rating agency said

that in that case it made an exception to its standard criteria for analysing such support, which focus on their irrevoca-bility. Fitch said that the B&B guarantee does not contain language describing it as “irrevocable” but that it made an ex-ception to its standard criteria for analys-ing guarantees because it considers that governments do not make such guaran-tee commitments lightly.

S&P in late July raised the ratings on B&B’s mortgage covered bonds from AA to AAA — without giving any credit to the guarantee because it had “not received comfort that the guarantee arrange-ments meet our sovereign guaranteed debt criteria for rating substitution”. S&P said that it had reduced its asset-liability mismatch classification of B&B’s pro-gramme from “moderate” to “low”.

“There is so much more ratingshopping going on” page 31


MONITOR: RATINGS

Covered bond trustee roles vary wide-

ly from country to country, said Standard

& Poor’s in a report focussing on trus-

tee-like roles in the fi ve largest markets

released in late August, reaffi rming the

rating agency’s view that not all covered

bonds are created equal.

While all covered bond programmes

benefi t from trustees, or trustee-like enti-

ties, the names, nature and scope of those

appointed to safeguard bondholders’ in-

terests vary signifi cantly by jurisdiction,

said S&P. Th eir roles range from rather

passive to highly active depending on the

country, said the rating agency.

“Th e trustee roles diff er signifi cantly

in diff erent countries,” said Sabine Dae-

hn, credit analyst at S&P, in a podcast that

accompanied the release of the report, “as

we, for example, look at the powers trus-

tees have in various jurisdictions.

“You have countries like the UK or

Germany where trustee-like entities have

a much more active role within covered

bond programmes.”

For example, in both Germany and

the UK, trustees must sign off on new

issuance — in Germany’s case it is the

cover pool monitor (Treuhänder) and in

the UK it is the bond trustee and security

trustee who act together.

S&P said that in addition to signing

off on new issues the Treuhänder super-

vises the portfolio to ensure that it com-

plies with covered bond regulations and

that overcollateralisation levels are com-

mensurate with the regulatory overcol-

lateralisation requirements.

Th e Treuhänder has the power to

request and check all information re-

quired to review the eligibility of the

programme, and remove or cancel assets

from the cover pool accordingly.

In the UK, the bond trustee and se-

curity trustee approve amendments or

corrections to transaction documents

and bond terms, as well as authorise the

termination and appointment of agents

and servicers.

“When we, however, look at a country

like Spain and the cédulas programmes

there,” added Daehn, “as long as the bank

itself is solvent there is not really a trustee

employed.”

Th e report said diff erent covered bond

programmes in Spain use diff erent ap-

proaches but cédulas hipotecarias and

cédulas terrioriales, for example, do not

employ trustees when solvent, but rather

the issuer itself manages the cover pool,

supervised by the Spanish regulator.

Th e trustee role also varies aft er a de-

fault, said S&P, with Daehn, however,

identifying as a common theme that “trus-

tee-like entities have more power than be-

fore in that usually new entities enter the

scheme or enter for the fi rst time.”

For example, in Spain and Denmark,

a trustee-like entity — which enters for

the fi rst time at the point of insolvency —

examines the cover pool, she said.

“Depending on the jurisdiction, they

might have sole responsibility for manag-

ing the cover pool, the cover programme,

like for example in Denmark,” she added.

According to the S&P report, dur-

ing insolvency proceedings Finanstil-

synet, the Danish fi nancial supervisory

authority, appoints a trustee to manage

the cover pool and provide it with quar-

terly reports. In the case of a mortgage

bank, the Finanstilsynet appoints a liq-

uidator (Kurator) who administers the

cover pool and has the same rights over

the mortgage loans as the insolvent bank

would have had.

TREUHÄNDER & CO

Active or passive? S&P examines trustees

METHODOLOGY UPDATE

October at the earliest for S&P counterparty fi naleStandard & Poor’s does not expect to publish updated counterparty criteria for covered bonds before October, the rat-ing agency announced in mid-August.

It said that it is “giving due consid-eration to the opinions expressed” dur-ing a consultation period that ended on 4 May and yielded “signifi cant” levels

of feedback.S&P at the beginning of June report-

ed on the comments it received on its proposals.

Karlo Fuchs, analytical manager for covered bond ratings at S&P, told The Covered Bond Report that for internal reasons the rating agency had not been

able to advance as quickly as originally intended.

The rating agency had been receiving questions from market participants about whether fi nalised criteria would be re-leased before a possible wave of bench-mark supply, and so wanted to provide an update about the timing, he added.

Sabine Daehn: “You have countries where trustee-like entities have a much

more active role.”


MONITOR: MARKET

Market EUROS

ING leads covered rush as senior swoonsEuropean banks raised close to Eu20bn

of funding through benchmark covered

bonds in seven business days at the end

of August as the asset class left the senior

unsecured market trailing.

Ballooning spreads on senior unse-

cured debt meant that market was yet

to reopen post-summer as Th e Covered

Bond Report was going to press, and cov-

ered bonds were the only game in town.

Th e Netherlands’ ING reopened the

market on 24 August with the fi rst bench-

mark since 5 July, issuing a Eu1.25bn 10

year at 80bp over mid-swaps. Martin Ni-

jboer, head of long term funding at ING,

told Th e Covered Bond Report that the

bank had felt a sense of responsibility in

reopening the market.

“You want to do a good, successful

transaction that means the market re-

mains open for others,” he said. “If you

go out with a 10 year you should show

leadership and be strong.”

Issuers that followed paid tribute to

the Dutch bank.

“ING gave us a lot of confi dence that

the market had opened,” said John Paul

Coleman, head of capital raising and

term funding at RBS, which tapped the

market a week later. “It was an excellent

deal and the catalyst for all this issuance.”

Th e reopening expanded quickly, with

UniCredit selling the fi rst OBG bench-

mark since Italy was drawn towards

the centre of the euro-zone sovereign

debt crisis in mid-July (see Q&A with UniCredit’s Philipp Waldstein for more).

“Everyone was expecting a short dat-

ed deal from a German or Scandi issuer

to reopen the market,” said a syndicate

offi cial, “but it was a 10 year, and then

you’ve got all these other things coming

out like a 10 year OBG. It does show quite

a strong reopening for the market.”

Deals for Eurohypo, UBS and Nordea

Bank Finland also came that week, but

with Abbey National Treasury Services,

Barclays Bank, BPCE SFH, Caisse de Re-

fi nancement de l’Habitat, Crédit Agricole

Home Loan SFH, Erste Group Bank, RBS,

SpareBank 1 Boligkreditt and Swedbank

Mortgage all following, overall demand

eased. Orders for a Eu1bn 10 year trans-

action for Norway’s SpareBank 1 Bolig-

kreditt, for example, came in slower than

expected and guidance was revised to re-

fl ect the worsening market conditions.

“We felt that the low 60s was a fair start-

ing point but the revision of the guidance

was a refl ection of market conditions – a

combination of heavy supply and a shakier

credit market overall,” said Arve Austestad,

chief executive at SpareBank 1 Boligkreditt.

Secondary spreads came under pres-

sure — particularly with new issue premi-

ums on the supply being high. A portfolio

manager said the new issue premium on

ING’s reopener — put at 15bp by several

market participants — was scary and that

secondary market spreads were widening

by 70%-80% of new issue premiums.

“How long can this continue with

wide primary issues?” he asked. “All the

curves are going wider.”

However, although sympathetic to con-

cerns about secondary spreads, a syndi-

cate offi cial said that issuers and his peers

should be less worried about where exactly

new issue premiums were coming in at.

“If you look at the moves in sovereigns or

in senior unsecured,” he said, “these bizarre

discussions around new issue premiums

seem to be very misguided. Th e questions

are not relevant, especially when seeing such

high unsecured levels and sovereigns.

“We’ve seen a lot of diff erent deals,”

he added, “which have been bought up

with many diff erent types of investors, so

what this really shows is that it is a really

strong market in horrifi c conditions.”

ING: “The catalyst for all this is-suance.”

0

50

100

150

200

250

300

350

Dec-09 Source: UniCredit

Mar-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11

bp

Banks SEN A Banks SEN AA iBoxx € Banks

iBoxx € Covered iBoxx € France Covered iBoxx € Germany Covered

Covered bonds outperform senior unsecured

The CoveredBond ReportThe Covered Bond Report is not only a magazine, but also a website providing news, analysis and data on the market.

Are you a covered bond investor?Then you could be receiving free daily news bulletins from The Covered Bond Report and access to its coverage of the market as well as its proprietary database of new issues and cover pool data links.

If you would like to gain complementary access to The Covered Bond Report’s website and to receive free copies of The Covered Bond Report’s magazine, contact Neil Day, Managing Editor, at [email protected] or visit news.coveredbondreport.com to register*.

*Investors directly linked to covered bond issuers may not qualify for this offer.


MONITOR: MARKET

Swedbank Mortgage launched the first dol-

lar benchmark covered bond in a month on

24 August, achieving cheaper funding than

available in Swedish kronor or euros.

Leads Bank of America Merrill Lynch,

Barclays Capital, Credit Suisse and JP

Morgan gave initial price talk in the high

70s over mid-swaps for the five year deal,

and priced a $1bn issue at 82bp over.

The Swedish issuer last sold a dollar deal

in March, a $2bn transaction split into fixed

and floating rate tranches of $1bn each. The

three year FRN was priced at 45bp over

three month Libor and the five year fixed

rate piece at 71bp over mid-swaps.

Although the funding levels for the lat-

est transaction were a little higher, Martin

Rydin, head of long term funding at Swed-

bank, told The Covered Bond Report that

this was to be expected given the challeng-

ing market conditions and given that the

transaction heralded the reopening of the

dollar covered bond market.

Rydin added that the bank had ob-

tained funding that was around 10bp

cheaper than in the euro benchmark

market, and also inside levels in the do-

mestic market.

“The dollar market was by far the

most cost efficient,” he said.

As well as the dollar market being

cheaper, Rydin said the issuer expected

to have a first mover advantage.

“I think we were one of the first banks to

update our 144A covered bond programme

following our Q2 results, so I guess we were

one of the first who actually were able to is-

sue,” he said. “One reason for us to move

was that we thought we’d be the one only

ones looking at the dollar market, while the

euro market might be quite crowded.”

Coming from a financially sound ju-

risdiction also helped, said Rydin.

“Sweden in general has good and sound

finances, which means that there is a safe

haven bid regarding Sweden,” he said, “and

it’s probably also a positive factor that Swe-

den is not a part of the euro-zone area.”

The last prior dollar benchmark was

a $2bn five year for Canada’s Bank of

Nova Scotia at 42bp over mid-swaps on

26 July.

SWISS FRANCS

Swissies offer growing respiteThe Swiss franc market has provided cov-ered bond issuers with greater volumes of funding this year, offering welcome respite from the euro-zone’s problems.

Foreign covered bond issuance in the second quarter rose from Sfr1.625bn in 2010 to Sfr2.125bn (Eu1.92bn) this year, and from Sfr1.175 in 2009. Supply in the year to the beginning of August increased from Sfr6.6bn in the same period of 2010 to Sfr7.2bn, ac-cording to figures from Credit Suisse.

This made Swiss francs the fourth largest currency for international cov-ered bond issuance after euros, dollars and sterling. In the first seven months of the year, 15 issuers from 10 countries

tapped the currency with either new is-sues or reopenings.

“Whenever we’ve seen difficult times in Europe,” says Andre Schmid, head of Swiss franc syndicate at Credit Suisse, “the Swiss market has been open for top quality issues. As an issuer you can use the Swiss market as a strategic market, but you have to be aware that average transaction sizes are smaller.

“But compared to euro deals, you get more interesting levels,” he added.

Maturities in the Swiss market have varied from five to 10 years in 2011, said market participants. Schmid said the “sweet spot” for broadly distributed issues was between four and six years.

Despite Royal Bank of Canada hav-ing launched the tightest transaction of the year, the Swiss franc market has been dominated by core issuers from Scandi-navia and France. That it is not to say the market is not open to other jurisdictions, according to UBS Swiss syndicate official Fabian Welandagoda, who said that Ger-man risk would also have been welcomed, but was too expensive on a swapped basis.

“We believe the market is open for other jurisdictions, too,” he said, “but professional investors increasingly do look at the rating/credit metrics of the underlying credit as well and expect a higher spread even if the cover pool consists of high quality assets.”

DOLLARS

Swedbank a euro opt-out in US


MONITOR: MARKET

SECURITISATION

RMBS pick-up more molehill than mountainMarket participants have cautioned

against reading too much into a pick-up in

European RMBS issuance in the fi rst half

of the year, suggesting that tough condi-

tions, regulatory disincentives and the at-

tractions of covered bonds could stymie

any continued recovery.

Standard & Poor’s in mid-August noted

that European issuance of residential mortgage

backed securities, excluding retained deals,

neared Eu30bn in the fi rst half of 2011, 20%

more than in the fi rst half of 2010. Th e rating

agency said improving collateral performance

and recovering investor sentiment could be

partly responsible for the moderate revival.

“As RMBS issuance has slowly returned,

there has been some shift in post-crisis

transaction structures,” said S&P, using the

example of standalone transactions, which

it said have gained traction.

However, market participants noted that

the increase was from a low base. Boudewijn

Dierick, head of structured covered bonds at

BNP Paribas, for example, was more scepti-

cal about the return of the RMBS market.

“Because the amount of issues in H1

2010 was relatively small, it does not need a

huge amount of deals more to get a 20% in-

crease,” he said, “but it is indeed a good sign.”

“Th e Dutch and UK markets are still the

only active RMBS markets,” he added.

S&P acknowledged any recovery was

limited to the UK and the Netherlands,

which together accounted for 95% of placed

RMBS issuance in H1 of 2011. S&P expects

this trend to continue into next year.

Dierick contrasted the recovery in the

UK and the Netherlands with Italy and

Spain — the two other European markets

that were the most active pre-crisis.

“Th e big diff erence is that, for example,

we have seen one or two Italian deals but

that’s it,” he said, “while pre-crisis Italy was

quite important.

“Spanish RMBS was also really big and

we haven’t seen those either, although

that’s more linked to the sovereign prob-

lems and the state of the housing market

in Spain, for example.”

Paolo Binarelli, CDO portfolio manager

at P&G SGR Alternative Investments, said

the Italian RMBS market is currently illiquid.

“It hasn’t been a very liquid market since

a couple years ago, as the bulk of outstand-

ing bonds is made of legacy paper and the

number of new issues has been very lim-

ited since the end of 2010,” he said. “I’m not

expecting that under current conditions is-

suance will improve, though of course any-

thing could happen.

“I think eventually they will probably

try a non-public way of issuing — probably

through fi nding funding with the ECB.”

Binarelli added that covered bonds

were more viable because issuers could ac-

cess the market more swift ly, thus enabling

them to act during a brief market upturn,

and because their investor base included

international and domestic investors.

Market participants have complained

about regulatory bias in favour of covered

bonds and said that better treatment for

RMBS would lead to an improved outlook.

“CRD IV indicated favourable treatment

for covered bonds,” Simon Collingridge,

managing director, structured fi nance, at

S&P, told Th e Covered Bond Report, “where-

as structured fi nance seems to be quite heav-

ily treated in things like Solvency II. I think

investors forget that not all covered bonds

are created equally and that there is actually

a higher degree of transparency with RMBS.”

Of 70 respondents to a poll on Th e

Covered Bond Report website, 39 said that

there is an unjustifi ed regulatory bias in fa-

vour of covered bonds over ABS while 31

disagreed — although Th e Covered Bond

Report’s readership might be more inclined

to considering any favourable covered

bond treatment appropriate.

BNP Paribas’ Dierick said it is very

diffi cult to get investors to acknowledge

RMBS because of the regulatory treatment

they face.

“Not necessarily for insurers or pension

funds,” he said, “but for bank investors, in

all their investments they take into account

whether it counts as liquid assets.”

Th e European Securitisation Forum

(ESF) and lobbyists have approached the

European Banking Authority (EBA) seek-

ing better treatment for the asset class.

“Netherlands and UK still the only active

RMBS markets”

“Not expecting that under current conditions issuance will improve”


MONITOR: LEAGUE TABLES

League Tables

These league tables are based on The Covered Bond Report’s database of benchmark covered bonds. For further details visit our website at news.coveredbondreport.com. Please contact Neil Day on +44 20 7415 7185 or [email protected] if you have any queries.

EURO BENCHMARK COVERED BOND RANKING

1 January 2011 to 31 August 2011

Rank Bookrunner Deals Amount (Eu m) Share %

1 BNP Paribas 49 12,789.17 7.93

2 Natixis 55 12,343.33 7.65

3 Crédit Agricole 41 10,550.00 6.54

4 UniCredit 48 10,517.86 6.52

5 HSBC 46 10,152.02 6.29

6 Barclays 39 10,096.67 6.26

7 Deutsche 36 9,724.52 6.03

8 UBS 36 8,492.08 5.26

9 Société Générale 30 7,412.50 4.60

10 RBS 23 5,902.50 3.66

11 Commerzbank 28 5,454.58 3.38

12 DZ 24 5,390.36 3.34

13 Danske 14 4,166.67 2.58

14 ING 16 4,087.50 2.53

15 LBBW 22 4,047.50 2.51

16 Citi 14 3,710.42 2.30

17 BayernLB 14 2,876.19 1.78

18 Nomura 14 2,791.67 1.73

19 Goldman Sachs 10 2,566.67 1.59

20 BBVA 9 2,550.00 1.58

21 Santander 10 2,525.83 1.57

22 NordLB 11 2,216.67 1.37

23 JP Morgan 11 2,150.00 1.33

24 Credit Suisse 9 1,904.17 1.18

25 Banca IMI 6 1,683.33 1.04

Criteria: Euro denominated fixed rate syndicated covered bonds of Eu500m or greater, including taps

MULTI-CURRENCY BENCHMARK COVERED BOND RANKING

1 January 2011 to 31 August 2011

Rank Bookrunner Deals Amount (Eu m) Share %

1 BNP Paribas 56 14,451.48 7.81

2 Barclays 53 13,660.90 7.38

3 Natixis 56 12,524.17 6.77

4 HSBC 55 12,339.64 6.67

5 Crédit Agricole 41 10,550.00 5.70

6 UniCredit 48 10,517.86 5.68

7 Deutsche 39 10,220.34 5.52

8 UBS 41 10,194.51 5.51

9 RBS 30 7,892.82 4.27

10 Société Générale 31 7,631.63 4.12

11 Commerzbank 29 5,635.42 3.05

12 DZ 24 5,390.36 2.91

13 Citi 17 4,298.36 2.32

14 Danske 14 4,166.67 2.25

15 ING 16 4,087.50 2.21

16 LBBW 22 4,047.50 2.19

17 JP Morgan 17 3,685.22 1.99

18 Santander 12 3,179.35 1.72

19 Nomura 15 2,910.33 1.57

20 BayernLB 14 2,876.19 1.55

21 BAML 12 2,794.12 1.51

22 Goldman Sachs 10 2,566.67 1.39

23 BBVA 9 2,550.00 1.38

24 Credit Suisse 11 2,219.34 1.20

25 NordLB 11 2,216.67 1.20

Criteria: Fixed rate syndicated covered bonds of 500m or greater, including taps, in euros, dollars and sterling

Don’t forget to visit our website at:

www.coveredbondreport.com


Q&A: UNICREDIT

UniCredit: More than covered


Q&A: UNICREDIT

Q At the end of August UniCredit was able to sell a Eu1bn 10 year obbligazioni bancarie garantite issue, only a few weeks aft er bail-out fears caused panic in the Italian gov-ernment bond market. Are you surprised how soon aft er-wards you were able to come to market?

A I have been on the road a lot, especially in 2011, continuous-

ly discussing with various investors the Italian covered bond

pool in particular, and I’ve always noted that the impression

they have of the Italian collateral is extremely high — and it

has always been extremely high.

Now, I was assuming that because of the crisis people

would have been put off . But in fact it turned out that they

hadn’t been put off , and that their positive appreciation of

the Italian collateral has remained, even when the level of

the crisis has increased. Th at’s been to me the surprise: that

the vast majority of the investors I have been in contact with

maintained a positive spin towards us.

However, it has always been clear that there is a broad

range of investors out there doing a fundamental qualitative

analysis, and obviously that hasn’t changed. It might have even

increased, because relative to other asset classes the cover pool

has become even more interesting. Even in comparison to the

sovereigns, it has become more interesting, because what

we’ve seen is a sovereign crisis, not a mortgage crisis. Th e fact

that we have been able to price the bond fl at to BTPs demon-

strates that in relative terms people appreciate it even more.

Furthermore, an investor called me up and said, look,

it’s even more impressive when you consider that if the ECB

were not there for BTPs then they would be much higher,

so some would consider that the deal eff ectively even came

through BTPs if looking at the pure market level.

“If we privilege covered bonds too much, other asset classes

will suffer even more”

A successful OBG issue in late Au-gust allowed UniCredit market

access in the wake of Italy being drawn into the crisis. But although UniCredit is keen to establish fur-

ther covered bond platforms, Philipp Waldstein, head of group strategic funding and portfolio at UniCredit, says that privileged treatment of the asset class should not be to the detri-

ment of others, such as RMBS. He shared his views with Neil Day.


Q&A: UNICREDIT

Q You focused there on the collateral and I guess that does refl ect the way that investors are looking because — al-though this is a sovereign crisis — fears about Italian banks increased with the sovereign volatility, hitting their share prices and senior unsecured spreads…

A The lower share prices are, in my view, due to the sover-

eign exposure that the banking industry has. And in that

respect it is directly correlated again to the sovereign risk.

So whether you have BTPs or you have senior bonds, in

the end you are exposed to the sovereign risk. If you have a

residential mortgage bond, yes, the bank might default, but

the underlying collateral will persist.

Q You clearly retained confi dence that you would be able to do something in covered bonds. It was nevertheless quite a surprise to many people last week when you did come out with a deal only one day aft er the market reopened and that it did go so well. Would you have gone ahead if ING hadn’t done its deal to reopen the market day before?

A I think it helped, no doubt. As I said, I stayed in contact with

investors and we knew that some of them would come in.

But then of course the best case is that you go on to achieve

broad distribution, which we ultimately managed to get.

I think it’s always a fi ne psychological line and obviously the

fact that there has been another issue before us was a help to us.

And we had no plan at all to be fi rst. Th at’s not the point here.

Even to be second is to be in a very nice position. And so we were

quite grateful, and I take my hat off to ING that they moved fi rst.

I think that was a bold move and they deserve credit for that.

Q How big a role have covered bonds played in your funding this year?

A Covered bonds to us are very strategic. We take them very seri-

ously and we believe that covered bonds are, and will be even

more so in the future a key anchor of our funding strategy.

So this year, when our funding plan is Eu32bn, we have

around about 30% of our funding in covered bonds. We

want to grow that to as large as 40% — we believe that is a

good mix that we will achieve in the medium term.

Q Is RMBS an option for UniCredit this year?A I don’t think it’s going to be an option this year. It could be

next year. We believe that there is room for both segments,

for covered bonds and ABS.

Th e ABS market has more of a branding issue than an is-

sue of substance. Performances in Europe are very good. You

fi nd problems in the States, but European ABS is performing

very well. It’s more a branding issue.

Within the context of regulatory discussions ABS has suf-

fered unfairly. My impression is that the regulatory sector is

thinking of giving a reassurance in terms of regulatory sig-

nalling to the market. I think the regulator deems it neces-

sary that ABS exists and wants to support it. Th ey acknowl-

edge the fact that signalling has so far not been given.

UniCredit is also working with the banking industry bodies

to reposition ABS through initiatives such as Prime Collateral

Securities (PCS), and I hope and expect that the regulatory side

will respond to such an initiative should it prove successful.

Q In covered bonds there is the labelling initiative. Do you think this will help the asset class? If so, how?

A Labelling is an important step because at some point we

need to define — from, to start with, a European perspec-

tive — what is a covered bond. That is undoubtedly a ques-

tion that the investor base has. I believe the regulator is

thinking about that as well. And, looking ahead, at some

point there will be a legislative definition from the regula-

tory side. But in preparation for that, labelling, driven by

the market side, is an important step to achieve ultimately

a legislative branding definition, too.

Q Th e European Banking Authority has been charged with coming up with the criteria for defi ning which assets should be included in liquidity buff ers. What’s your view on the way in which the Basel Committee proposed that covered bonds be treated in the Liquidity Coverage Ra-

Philipp Waldstein: “ABS has suffered unfairly”


Q&A: UNICREDIT

tio (LCR)? Do you think that CRD IV treatment might be more favourable?

A Th ere is no doubt that the covered bond is the supreme as-

set class. However, should the other components remain un-

changed, personally I believe that the current favouring of

the covered bond sector is suffi cient.

Should we improve the treatment of covered bonds? We can

partially improve it, but if we go too far we risk aff ecting oth-

er asset classes. If we privilege covered bonds too much, then

other asset classes will suff er even more. So — as much as I am

convinced that covered bonds are the supreme asset class — we

also need to be aware what is happening to senior debt, what is

happening to ABS, and what is happening to government debt.

I understand that the covered bond industry as such is

pushing forward, but I think at the end let’s not forget there

is already a privilege embedded — and rightly so — which is

in broad terms OK.

Personally I believe that a limited portion of ABS should

be included. It is a non-correlated asset class.

Th e prospect of ABS being included in liquidity buff ers

has been raised by some market participants, including a

Basel Committee member. But it’s hard to get a handle on

whether there is a realistic prospect of that happening or if it

is just wishful thinking.

It is at an early stage and it is very diffi cult to judge. But

there is still a long way to go before we will fi nd out the fi nal

version of the Liquidity Coverage Ratio.

And, as you say, there are clearly two lessons that have

been learned: government bonds are not without risk — that

is a lesson learned the hard way; and the other is that non-

correlated assets, like ABS, for example, provide from a credit

perspective a diversifi cation. Th e liquidity component of ABS

is less developed — we need to work on that — but at least

from a credit perspective they merit a positive consideration.

Q Th e explicit link between bank ratings and the ratings of their covered bonds in rating agency methodologies ties in a correlation between the two. Are you satisfi ed over-all with the way the rating agencies look at covered bonds and how they handle changes to their methodologies?

A Th e way that covered bonds are assessed by the rating agen-

cies, even within Europe, needs harmonisation. Because cov-

ered bonds in Germany and in Italy are assessed a little dif-

ferently in a way. So I appreciate that the rating agencies are

readdressing their methodologies. Are changes always han-

dled in the best way? I’m sure there’s room for improvement.

Overall I expect the agencies to conclude their work in 2012.

Q It is quite rare for one banking group to have as many dif-ferent issuers as UniCredit, with entities in Italy, Germa-ny, Austria and even Russia. Is that an advantage for you or does it pose any particular challenges?

A Th at is clearly a double advantage that we have. As an overall

group we profi t from the fact that we are partially a Ger-

man bank, partially an Austrian bank, and partially an Ital-

ian bank. So from an overall funding point of view we profi t

from that, because we have access to all these markets and

we are a credit in all these markets.

On top of that, we have the advantage of diversifi ed cov-

ered bond access, and it is a clear competitive advantage. We

are trying to maintain this and, as you say, we are gradually

stretching this out across the group and wherever possible

we will also set up covered bond platforms. Th at’s not going

to be in the same amount that we have seen in established

markets — Austria, Germany and Italy will always be the key

platforms — but you will see other ones that then operate in

the local market or do smaller amounts, private placements

— that is defi nitely a strategy that we are pursuing.

UniCredit OBG curve versus peers as of 18 August 2011

Source: UniCredit Research

UCGIM 5.25 Apr 23UCGIM 4.375 Jan 22

UCGIM 4.25 Jul 18

UCGIM 3.375 Oct 17 UCGIM 4.25 Jul 16

UCGIM 2.625 Oct 15

-100

-50

0

50

100

150

200

250

300

0 2 4 6 8 10 12

OBGs (ex-UCGIM) UCGIM Cédulas HipotecariasBTPS UK Covered Bonds Obligations FoncièresUnicredit Bank AG Pfandbriefe Bank Austria AG Pfandbriefe

“Wherever possible we will also set up covered bond platforms”


COVER STORY: RATING AGENCIES

Raters feel the heat

With temperatures running high, rating agencies have neededto keep a cool head and stand by their decisions in the face of pressure from issuers. But could the prospect of rating agencies themselves being red carded lead to rating shopping? Neil Day spoke to the arbiters of credit quality.



“Rating agency bashing appears to have

become a modern-day sport.”

Even those who — like UniCredit

analysts when they made this state-

ment — have no grudge against the rat-

ing agencies cannot fail to have noticed how credit ratings have

come to the fore in the wake of the financial crisis, often as the

subject of criticism.

But whereas in several asset classes such as sovereigns and

securitisation, rating agencies have been blamed for being too

lenient, the loudest complaints in the covered bond market

have come from issuers protesting too strict criteria in the post-

crisis era.

The worsening of the sovereign debt crisis this year has only

exacerbated the situation. The number of covered bond pro-

gramme downgrades made by Fitch, for example, doubled from

the first half of 2010 to the first half of this year as euro-zone

sovereigns weakened, and rating agencies have been faced with

unprecedented and unimagined scenarios (see Ratings section

for more).

Rating agencies say that they are just reflecting the new reality.

“Our original covered bonds rating criteria were developed

at a time of mostly — at least in Europe — stable sovereign

risks,” says Hélène Heberlein, managing director of covered

bonds at Fitch. “But now we have to deal with a different envi-

ronment in terms of sovereign credit ratings, and that has been

a novel thing.

“If you were coming from an emerging market context, may-

be that would have been different, but covered bonds have been

used mostly in Western Europe. We were not used to thinking

about what would happen if a country were downgraded se-

verely, for example.”

The changes in ratings and methodologies that have resulted

from the crisis are seen as unavoidable by the rating agencies.

“Many people obviously prefer ratings and methodologies

not to change,” says Karlo Fuchs, analytical manager for covered

bonds at Standard & Poor’s. “But a rating and the underlying

criteria have to be current — that is also enshrined in regula-

tions these days. Naturally that means that criteria might evolve

over time — even if the changes might not be as significant as

with the introduction of our ALMM methodology in 2009.

“Most people recognize that the environment has changed

significantly over the last few years, not least with the evapo-

ration of asset-based lending. We have to take account of these

changes and of new risks that have emerged by reflecting them

in our new criteria. If we had stuck with our previous way

of looking at risk, we would probably been accused of fair-

weather rating.”

And while Moody’s says that the last major review of its cov-

ered bond methodology, incorporating a more detailed cover

pool analysis, occurred as far back as 2005 — and which it says

“The regulators chose to give external ratings importance”



did not aff ect the stability of covered bond ratings — it is ready

to move again should that prove necessary.

“In line with our ongoing eff orts to strengthen analytical

quality, when credit conditions warrant, we may revise our

methodologies to capture the relevant risks,” says Juan Pablo

Soriano, managing director, structured fi nance, at Moody’s.

Straight talkingNowhere was the sport of rating agency bashing played more vig-

orously than when S&P revised its methodology to introduce its

asset liability mismatch (ALMM) risk criteria, which introduced a

formal explicit link between the rating of an issuer and its covered

bonds. Th e rating agency must have been prepared for a rough ride

— when announcing its plans it said that as many as 60% of cov-

ered bond programmes could face downgrades — but the reaction

S&P’s covered bond team faced clearly still smarts today.

“We understand that issuers feel strongly about the changes,

but as a rating agency we have to do what we believe is right —

and we have to invest time in explaining our views,” says Fuchs.

“We aim to be transparent to the issuers and to equip investors

with the information they need in order to assess our analysis

and if necessary to draw their own conclusions.

“If the changes result in an issuer cancelling its rating con-

tract, that is something we live with.”

At the heart of many complaints about S&P’s methodology

was a ranking of countries that aff ects the rating ultimately

achievable by an issuer.

“You are almost stepping on the pride of certain coun-

tries when they suddenly find themselves in a category that

they don’t think they belong to,” says Fuchs. “In challenging

the classification of certain countries, we were questioning

something that people have taken for granted. Emotions can

run high.

“But the AAA rating is our highest rating and you have to

deserve it. Th at is why we make sure that we are as transparent

as possible about our criteria for achieving it.”

Fuchs says that although S&P’s classification of Sweden in

its second highest category was initially seen as “totally out

of whack”, subsequent discussions proved constructive, Swe-

den’s law was changed, and the country won promotion into

category one.

“Superfi cially, covered bonds can be seen as very straight-

forward and simple” says Fuchs, “but as soon as you start to

drill down and look into things in detail, suddenly some aspects

might come up that you might not be aware of.

“So you can well argue that a disagreement is actually al-

most what we would like to see because a disagreement actually

prompts people to think, to basically accustom themselves with

what we are doing, and why we are doing something, and then

they can form their own opinions.”

However, S&P did not win everybody around and Fuchs ac-

knowledges that the rating agency has been dropped by issuers

as a result of its change in methodology.

Regulation agenciesIssuers might be more relaxed about ratings were some regula-

tory initiatives not putting even more importance on the views

of the agencies. Most dramatically, Solvency II, which will aff ect

the relative attractiveness of diff erent assets for insurance com-

panies in the European Union, puts not just covered bonds, and

not just highly rated covered bonds, but specifi cally triple-A

rated covered bonds in a privileged position. Similar, although

less restrictive, rating categorisations are set to be embedded in

the Basel III framework, too.

Th e rating agencies each point out that they did not ask to

be put in such a pivotal position in the markets but have argued

against it.

“Moody’s Investors Service has long supported the objective

of reducing regulatory overreliance on ratings,” says Soriano.

“By encouraging a diversity of credit risk measures and modi-

fying their use in the oversight regime, we believe regulators

could ensure that no individual opinion or measure causes ex-

cessive market reaction while also encouraging competition in

the market for credit risk analysis.”

Krishnan Ramadurai, a managing director in Fitch’s credit

policy group, says that the Basel II framework heralded the ar-

rival of rating agencies at the centre of regulations in 1999.

“Th e regulators chose to give external ratings importance un-

Helene Heberlein: “Now we have to deal with a different environment”

“We understand that issuers feel strongly about the changes”



der the standardised approach,” he says. “It’s fair to say that none

of the rating agencies lobbied for that or were happy with that.

“And unfortunately, as events have shown, some institutions

placed an excessive reliance on these ratings either to determine

capital requirements or to use them as triggers to decide on col-

lateral requirements in derivatives transactions.”

Fuchs at S&P says that this can result in rating agency opin-

ions having unintended consequences.

“Clearly we want to be a relevant opinion in the market —

don’t get us wrong,” he says. “On the other hand, what we do

not want is — and we say this on each and every rating letter

— a rating to become a recommendation to sell or to purchase

a security.”

Fitch’s Ramadurai welcomes initiatives among regulators,

under Dodd Frank as well as in the EU, to move away from

such a reliance.

Heberlein cites as an example of this trend a consulta-

tion paper released by Canada’s Department of Finance in

May on a proposed covered bond framework. In a section on

back-up swap and service providers, the Canadian govern-

ment asked: “Is there an alternative trigger for the establish-

ment of back-up swap and service providers that does not

rely on credit ratings?”

Unfortunately, when applied to the financial markets in gen-

eral, the answer to this question appears to be no — or, at least:

“Not yet.”

“The alternative is internal ratings,” says Ramadurai, “and it’s

fair to say, looking at the performance of these over the crisis,

that there have been some issues with these. While some banks

have done well, some banks have not done so well.

“So in the absence of any independent alternative, the process

of moving away from a reliance on credit ratings will take time.”

In the meantime, rating agencies have launched initiatives

to put more of the detail of their ratings into the public do-

main, while their methodologies have become more explicit

and transparent.

“In accordance with Moody’s ongoing efforts to strengthen

the transparency of the rationale supporting our credit opin-

ion,” says Soriano at Moody’s, “we have introduced Moody’s

specific credit indicators, which provide deeper information

on the key fundamentals of our ratings on covered bonds (i.e.

collateral score, Timely Payment Indicator (TPI), cover pool

“The AAA rating is our highest rating and you have to deserve it”

Undeterred by the experiences in the covered bond mar-ket of the three established rating agencies, DBRS is plan-ning to hire analysts to help it win a share of European covered bond ratings and is hopeful that it could have rated its first programme by the end of the year.

The Toronto-headquartered rating agency released a publication, “Rating European Covered Bonds”, in August that updated its methodology. Keith Gorman, senior vice president, US and European structured finance at DBRS, says that this comes as part of a push by the firm into the covered bond market.

“DBRS has established itself back in the European RMBS market and the ABS market over the last 12 months, particularly with the ECB second ratings requirement for repo eligibility,” he says. “We’ve rated more RMBS, ABS, and SME CLO deals, particularly in Spain, Portugal and the Netherlands.

“And with this development of the platform in London, getting back into the covered bond space is just a natural progression. Most issuers we’ve been working with and that we’ve provided some credit analysis for over the last 12 months, they’ve shown a keen interest in us providing a covered bond rating as well.”

DBRS previously started a push into the covered bond market in autumn 2007, announcing its methodology and taking on staff, but the team was disbanded with the deepen-ing of the financial crisis. The rating agency has since then, however, rated all Canadian covered bond programmes.

Gorman, based in New York, is leading European cov-ered bond ratings for DBRS but says that the rating agen-cy is looking to build a team in London. He says that he expects the firm to have begun rating European covered bonds by the end of the year.

Karlo Fuchs, analytical manager for covered bonds at Standard & Poor’s, says that S&P welcomes DBRS’s move.

“We encourage free and fair competition because it al-lows investors to get different views on the same risk and enables them to determine which ratings are credible and useful,” he says.

DBRS’s Gorman says that the methodology update did not contain any major changes.

The rating agency previously assigned jurisdictions to different buckets as part of its rating methodology. Gor-man says that the rating agency decided not to publish a new ranking in its update.

“We’re probably going to publish that on a transaction by transaction basis initially, with the expectation of updat-ing our criteria to generalise all of the jurisdictions,” he says. “Because we don’t have the back-testing of the out-standing ratings, we didn’t feel that we wanted to initially bucket the jurisdictional assignments.

“We’d rather see how things progress, see if maybe there are any programmes within a jurisdiction that might have some strengths above the established law and if the law does develop then obviously that’s an input that could change over time.”

DBRS targets Europe — again



losses). Aggregating this data every quarter by country and

per issuer outlines to investors the sensitivity of covered bond

ratings, changes in the issuer rating and the loss assumptions

Moody’s assigns to cover pool assets.”

Rating swappingA very public falling-out between an issuer and one of its rating

agencies occurred when Realkredit Danmark said in June that

it would no longer work with Moody’s because of fundamental

disagreements over the rating agency’s analysis of refi nancing

risk resulting from adjustable rate mortgages and hence de-

mands for more overcollateralisation.

“Th e decision was taken because Moody’s, as a result of its

model calculations, demanded that Realkredit Danmark pro-

vide an additional excess cover of Dkr32.5bn (Eu4.36bn) if it

wanted to keep its current Aaa rating,” said the Danish issuer.

“Realkredit Danmark has discussed the fundamentals of the

matter with Moody’s in order to understand the rationale be-

hind its rating model, but has concluded that the parties disa-

gree about the fundamentals.”

Although complaints about Moody’s view were widespread

across the Danish mortgage industry, Realkredit Danmark’s move

was a more extreme action than any of its peers. BRFkredit, for ex-

ample — despite facing more severe rating actions and being “sur-

prised and confused” by Moody’s — is soliciting a rating from S&P,

but maintained its relationship with Moody’s. Realkredit Danmark

has meanwhile been reported to be considering hiring Fitch to rate

its covered bonds instead — S&P already rated its issues, triple-A.

While nobody has argued against an issuer’s right to choose

its rating agencies, the prospect of covered bond issuers switch-

ing from one rating agency to another where they are more fa-

vourably treated raises the spectre of ratings shopping, which

has haunted the securitisation market since it fell from grace.

Th ere, allegations of ratings shopping — the practice whereby

ABS arrangers would solicit a rating from the agency aff ording

it them the loosest terms — continue to stymie a recovery.

But while the threat of lawsuits and regulation — not to

mention the slow pace of issuance — might have lessened rat-

ings shopping in the US securitisation market, Fuchs at S&P

says that it is becoming more prevalent in covered bonds.

“Th ere is so much more rating shopping going on,” he says.

“From an issuer’s perspective, why should you penalise yourself

if you can achieve a higher rating somewhere else and investors

do not appreciate the diff erence?”

Relationship counsellingFitch’s Heberlein says that it is nevertheless important to understand

that issuers’ relationships with rating agencies are more complex

than being based solely on the rating that is ultimately awarded.

“Issuers are regularly upset by their rating agencies,” she

says, “but we cannot draw general conclusions every time one

issuer decides not to go along with a particular rating agency

aft er they have been rated. Obviously it’s because they were not

happy with something, but you cannot infer from that that they

are taking another rating agency simply because they could

have a higher rating or lower overcollateralisation supporting

the covered bonds rating.”

Heberlein says that the change could be relationship or com-

munication driven.

“How our opinion is formed and how we explain it is prob-

ably even more important to issuers than the fi nal rating out-

come,” she says.

New arrival DBRS could nevertheless fi nd itself in the po-

Juan Pablo Soriano: “When credit conditions warrant,we may revise our methodologies”

“Moody’s believes that rating shopping is a harmful practice”



sition to benefi t from any dissatisfaction with the three estab-

lished players. However, Keith Gorman, senior vice president,

US and European structured fi nance at DBRS plays this down

as a factor in the fi rm’s move.

“DBRS views itself as another service provider to investors

and other market participants by providing a transparent rat-

ings approach,” he said.

However, a market participant says that any new entrant into

the market could face a tough time, having to choose between

adopting a rigorous approach that could put off issuers and a

more lenient approach that risked being viewed as a “me too”

opinion.

HSBC Trinkaus analysts have suggested that lower rated is-

suers, such as some in Portugal and Spain, might benefi t from

turning to DBRS. Th ey said that while triple-B issuers might

not be able to reach triple-A ratings for their covered bonds,

those that are only just sub-investment grade rated could hope

to achieve single-A ratings for their covered bonds.

Investors the ultimate arbiterAs an ex-auditor, S&P’s Fuchs cites the example of Enron ac-

countant Arthur Andersen, which collapsed with its reputation

in tatters, as a warning to any independent arbiter of quality

that puts business before integrity. In this respect, the fall-out

from S&P’s change of methodology is something of a badge of

pride for the rating agency.

“We had a quite lengthy request for comment process and

people were clearly threatening us with withdrawing their busi-

ness and in the end also did so,” he says, “so the fact that we

were willing to actually move forward with those criteria is

something that shows we didn’t take that side into account in

our decision.

“Our key constituency are the investors,” he adds. “The is-

suers pay us, but we are only accepted by the market if we

remain independent. Being independent, really having integ-

rity — that is really what we are keen to do and that is what

we have done.”

However, Soriano at Moody’s warns that developments in

investors’ attitudes could raise the risk of ratings shopping.

“Moody’s believes that rating shopping is a harmful prac-

tice that can exacerbate the potential confl icts that credit rating

agencies face as a result of being paid to provide credit ratings,”

he says. “A recent survey suggests that the covered bond market

is becoming a one rating agency market, with approximately

70% of the investor base being satisfi ed with only one credit

rating for a covered bond programme.

“In order to mitigate the potential for rating shopping in

such an environment, extensive and widely disseminated dis-

closure of information is important so that investors and other

market participants are placed in a position to form their own

opinions and also facilitate unsolicited ratings.”

But another trend among investors cited by Soriano off ers

hope that issuers may feel less desperate about doing everything

they can to achieve the Holy Grail of ratings. He says that ac-

cording to recent surveys, approximately 30% of the covered

bond investor base requires a triple-A rating, meaning that 70%

can manage without the highest ratings.

Fuchs at S&P also expects more comfort with lower ratings.

“Whereas in the past it was predominantly a triple-A prod-

uct, going forward it will no longer be so,” he says. “Th ere is

quite a wide rating spectrum within investment grade and that’s

something people might get more accustomed to.

“Double-A is still a solid investment grade rating.”

Karlo Fuchs: “There is so much more ratingshopping going on”

“DBRS views itself as another service provider to investors”


NORWAY: SAFE HAVEN

Northern lightNorway’s allure has only grown as the mood surrounding other

sovereigns has darkened, enabling its covered bond issuers to expand their horizons to the US and Australia. Crisis measures at home have

meanwhile boosted domestic issuance — although liquidity might have to be improved for the full benefits of Basel III to be felt.

Susanna Rust reports.

The Aurora Borealis over Andfjorden, Norway. (Photo: Frank Olsen)


NORWAY: SAFE HAVEN

I t is perhaps difficult to imagine that in 2007, when

Norway became a covered bond issuing jurisdiction,

some investors questioned whether it was worth open-

ing a credit line to the country.

This was based not on a particular reluctance or

concern about the quality of debt stemming from the country,

but on an assessment of whether a limited supply of Norwegian

debt was worth the time, effort and resources necessary to open

and maintain a line.

“At the beginning, Norway was not interesting enough for

some investors because we are a small country and not in the

EU,” says Thor Tellefsen, senior vice president and head of long

term funding at DnB Nor, parent of Norway’s largest covered

bond issuer, DnB Nor Boligkreditt.

But the factors that might previously have caused investors to

question the value of opening credit lines are the very ones that

have of late appealed to accounts seeking refuge from the euro-

zone sovereign debt crisis and global economic uncertainty.

“All this is now in our favour,” says Tellefsen.

He contrasts Norway’s budget surplus with the budget defi-

cits of other European countries in 2010, highlighting net gov-

ernment wealth of around 160% of GDP — thanks largely to the

country’s oil — and low unemployment, of around 3%.

Erica Blomgren, chief strategist, Norway at SEB in Oslo, says

that the Norwegian economy and housing market are key ele-

ments supporting the country’s covered bonds, especially given

the state of the global economy.

“Norway has much better prospects of good growth in that

you have a whole different situation in terms of the possibilities

of stimulating the economy, both via interest rates but also fiscal

policy,” she says. “Norway is dependent on the global outlook,

but arguably less so than other countries because its economy is

more sheltered from abroad, with non-oil exports constituting

less than 20% of mainland GDP.”

Julia Hoggett, managing director, head of covered bonds

and FIG flow financing for EMEA at Bank of America Merrill

Lynch, identifies strong macroeconomic fundamentals, cur-

rency independence, and balance sheet strength as three main

reasons why the Nordic area, in particular Sweden and Norway,

is benefiting from a safe haven bid.

“There has been a step change in what markets focus on over

the summer,” she says. “One of the biggest is realising that we

will be in a slow growth/no growth environment for some time

and that we will not be able to reinflate our way out of the eco-

nomic downturn quickly.

“That leads to people being exceptionally focused on balance

sheet strength, including in the context of a potential down-

turn. It doesn’t matter if you are a sovereign, a corporate or fi-

nancial — it’s your balance sheet that matters.”

In this context investors will perceive Norway’s currency in-

dependence and consequent discretion about any contribution

“We’ve been filling our boots with the stuff.”


NORWAY: SAFE HAVEN

to assistance for distressed euro-zone sovereigns, and its posi-

tive overall balance position as strengths, she says.

Indeed, according to SEB Norwegian fi xed income research

the fl ight to safety has pushed Norwegian yields to levels where

banks receive a better return by depositing money overnight at

the central bank than buying government bonds with maturi-

ties of up to eight years.

Arve Austestad, chief executive of covered bond issuer Spare-

Bank 1 Boligkreditt, says the pricing of Norwegian government

debt is “abnormal”, and that there is a diff erential of more than

150bp between government bonds and covered bonds.

“I don’t think you will fi nd many other countries where this

is the case,” he says.

Michael Riddell, retail fi xed income fund manager at M&G

Investments, provided an investor’s perspective on the prevail-

ing fl ight to quality bid in a Bond Vigilantes blog post at the

end of July. Th e “quest” for a safe haven in which to park funds

is “propelled by an imploding euro-zone and US politicians that

are seemingly looking to bring its $14tr poker game to a spec-

tacular fi nale by committing collective hara-kiri”, he wrote.

Credit default swap levels indicated Norway to be the safest

sovereign in the world, he noted, describing the strong bid for

Norwegian government bonds, alongside German and Swedish

government debt, as justifi ed.

“Indeed, we’ve been fi lling our boots with the stuff over the

past few months,” he said, “and given our well documented

ongoing nervousness regarding a number of sovereign states’

creditworthiness, we think that there’s still signifi cant value in

the safest AAA markets.”

Neither US nor euro risksTh e perceived low sovereign risk and strength of the Norwegian

economy are also very much at the front of covered bond mar-

ket participants’ minds.

“Th e sovereign situation should not be underestimated,”

says Fritz Engelhard, German head of strategy at Barclays Capi-

tal in Frankfurt, pointing to the stability of Norwegian covered

bond spreads in US dollars in support of this.

“Dollar denominated Norwegian covered bonds only wid-

ened by around 1bp-3bp, while French names for example all

widened substantially in dollars,” he says. “Th is shows that in-

vestors appreciate that Norway is separate from the turmoil in

the euro-zone.”

Th ree Norwegian covered bond issuers have tapped the dol-

lar market: DnB Nor Boligkreditt, Nordea Eiendomskreditt and

SpareBank 1 Boligkreditt. DnB Nor was the fi rst to launch a

Erica Blomgren, SEB: “Norway’s economy ismore sheltered from abroad”

88

90

92

94

96

98

100

102

Mar. 08 Sep. 08 Mar. 09 Sep. 09 Mar. 10 Sep. 10

UK US Euro area Nor Swe Japan Den Source: Finanstilsynet

Norway’s GDP growth unmatched

Inde

x re

base

d to

200

8 =

100


NORWAY: SAFE HAVEN

dollar transaction, in October 2010, and was followed by Spare-

Bank 1 two weeks later. Both have since returned to the US

market, in March and May this year, respectively.

SpareBank 1’s Austestad says that strong fi nancials in the

underlying banks and the strength of the sovereign’s balance

sheet meant that when they were fi rst launched Norwegian

covered bonds “fell into the same bracket price-wise” as other

Scandinavian covered bonds.

“Th roughout and since the fi nancial crisis Norwegian cov-

ered bonds have been pretty stable, and especially in this mar-

ket that is attractive for many investors,” he says.

While the pricing of Norwegian covered bonds has been

fairly stable since 2010 in absolute terms, adds Austestad, since

the spring of 2010 they have traded tighter than French cov-

ered bonds, whose spreads have widened, with the diff erential

to Germany’s Pfandbriefe narrowing.

He says that the strength of the sovereign as something of

a unique selling point amid concerns over the sustainability of

several euro-zone sovereigns’ debt levels eased SpareBank 1’s

access to the US market.

“The sovereign situation helped us to exploit other markets

where we would not have had the same comparative advan-

tage, and helps us to stand out from our competition,” he says.

“In this environment it is more about picking the best credit

exposure and at the moment Norway is in a comparatively

strong position.

“Of course it is easier to get our message across now than be-

fore, and to a larger extent a distinction is now being drawn be-

tween Norway and other Scandinavian countries, while when we

started issuing most investment bank analysts looked at Scandina-

via as one.”

Tellefsen says that DnB Nor’s venture into the US required it

to explain to investors that the Norwegian residential mortgage

market is the “very opposite” of the subprime market in the US,

but that accounts were all “very impressed” with the Norwegian

economy and Norwegian issuers.

“European investors have always been interested in Norway,

but for investors further away it is very helpful that Norway is

so outside the euro-zone problems,” he says.

Th is isolation also played a part in helping DnB Nor ac-

cess the Australian market, according to Tellefsen. DnB Nor

launched its fi rst Australian dollar issue in May, a A$600m

(Eu446m) fi ve year deal that was also the fi rst Australian dol-

lar benchmark covered bond from a European issuer since the

onset of the fi nancial crisis.

“It was easier for us to go to Australia now than it would

have been three years ago,” says Tellefsen.

Hoggett says that Norwegian covered bonds appeal to US ac-

counts seeking access to mortgage markets they see as correlated

to the performance of economies with which they are comfortable.

“Th e view of Norway as one of the strongest covered bond

jurisdictions is increasingly growing in the US and is cemented

in Europe,” she says.

Housing market heats upIf the case for Norwegian covered bonds, at least from a fun-

damental credit perspective, seems rather one-sided, then this

boils down to their strengths outweighing their weaknesses, ac-

cording to market participants.

A research piece on Norwegian covered bonds published by

Barclays Capital lists among relative weaknesses an absence of

mandatory overcollateralisation in the Norwegian framework

and a lack of transparency rules. But Jussi Harju, vice president,

covered bond analyst at Barclays Capital, says that these weak-

nesses veer towards being academic, and are in practice oft en

mitigated. So while the Norwegian legislation does not include

transparency rules, Norwegian issuers in practice provide good

disclosure, with the website of the Norwegian Covered Bond

Council also useful in this regard.

And while some analysts have argued that investors holding

Norwegian covered bonds do not have recourse to the larger,

parent banks of an issuer because the latter is a specialist entity,

Harju says that this is more of a theoretical concern.

“Given that the mortgage business is the core business

of the parent bank there is a pretty low chance of it walking

away from the covered bond issuing entity in times of stress

given that it provides the bulk of funding for its core mortgage

Thor Tellefsen, DnB Nor: “It is very helpful that Norway is so outside the

euro-zone problems”

“The sovereign situation helped us to exploit other markets”


NORWAY: SAFE HAVEN

business,” he says. “The incentive to step back from the pro-

gramme is rather marginal.”

SEB’s Blomgren says that the stability in house prices in Nor-

way over the past years could raise the question of whether this

lack of a correction could be a risk for the covered bond market,

but that the answer would be negative on account of healthy

overcollateralisation levels and prevailing loan-to-value ratios,

and the options available to policymakers to prevent a collapse

in house prices should the need to do so arise.

Property prices in Norway have been rising. In a presentation

on supervision and macroeconomic surveillance in Norway de-

livered in July, Emil Steff ensen, deputy director general at Finan-

stilsynet, said: “House price infl ation and household indebtedness

in the current low interest and low unemployment environment

is the most important fi nancial stability issue in Norway, besides

challenges related to the sovereign debt problems in Europe.”

Blomgren says that the rise in house prices has so far been

addressed by Finanstilsynet at the beginning of 2010 introduc-

ing guidelines that mortgage fi nancing should not exceed a

loan-to-value of 90%.

“Th is is one way to control the rise,” she says, “in additional

to hiking interest rates, which are very low at the moment.”

According to Steff ensen’s presentation, the results of a survey

of mortgage fi nancing and LTV guideline compliance sched-

uled for August would be followed by a decision about whether

stricter regulation or tighter guidelines are necessary.

Barclays’ Engelhard notes that the housing market could be

the source of some concern about a potential overheating, but

says that in his view there is no imbalance to be worried about.

“Norges Bank has already started to increase interest rates to

deal with the situation of too cheap funding, but overall we do not

think there is a real disequilibrium,” he says. “Th e rise in prices

refl ects some scarcity, and that the Norwegian economy is pretty

isolated from the heavy ups and downs of the global economy.

“It’s really diffi cult to fi nd any serious weak-spots,” he adds,

“and that’s what makes Norwegian covered bonds so attractive.”

Hoggett at Bank of America Merrill Lynch says that the

overall picture for Norwegian covered bonds is positive.

“In the context of a slowing global economy the perform-

ance of Norwegian mortgage assets is very good,” she says.

“Th eir nature and behaviour seems to be relatively stable so I

don’t see a reason to think of Norway as anything other than a

very good place on which to be focussed.”

Domestics boosted post-swap schemeAccording to Kristian Fiskerstrand, funding and risk manage-

ment at Terra BoligKreditt, the biggest developments in Nor-

wegian covered bonds over the four years since the legislative

framework was launched have arguably taken place in the do-

mestic market.

“On the international level, especially in Germany, investors

were already familiar with covered bonds, but in Norway it was

a completely new market,” he says. “Th ere are more investors in

the product now than a few years ago, and, with the Basel III

regulations, banks that used to buy senior unsecured debt are

now buying covered bonds instead, so that is providing more

liquidity to the market.”

Terra, for example, has in the past year been able to issue

domestic covered bonds in larger sizes than previously, and has

been taking advantage of this, says Fiskerstrand.

“We have raised Nkr5.9bn (Eu760m) in the domestic market

so far this year, including one fi ve year issue of Nkr3bn, with

this issuance replacing our euro market activity for the fi rst half

of the year,” he says.

SpareBank 1 has also been more active domestically, accord-

ing to Austestad.

“Since August-September 2010, volumes have been picking

up,” he says.

Key to the development of the domestic covered bond mar-

ket was a swap scheme introduced by the central bank, Norges

Bank, in October 2008. Th is allowed covered bonds (obligas-

joner med fortrinnrett, OMFs) to be exchanged for Treasury

bills in a bid to alleviate liquidity problems facing Norwegian

banks at the time.

A Norges Bank Economic Bulletin from November 2010 said

that the arrangement “greatly increased” covered bond issu-

ance, boosting the growth in the number of specialist mortgage

companies authorised to issue the product. Before the scheme

was introduced there were seven such entities; now there are 24

covered bond issuers registered with Finanstilsynet.

SEB’s Blomgren says that the arrangement was essential in

kicking off the domestic Norwegian covered bond market, with

Arve Austestad, SpareBank 1: “It is easierto get our message across now than before”


NORWAY: SAFE HAVEN

around Nkr230bn of a possible Nkr350bn issued under the

scheme.

And DnB Nor’s Tellefsen says that the size of the swap

scheme, at around Eu45bn equivalent, compares favourably

with a Eu60bn covered bond purchase programme launched by

the European Central Bank in July 2009, in that it shows “the

willingness and ability of the central bank to buy Norwegian

covered bonds”.

Th e last auction under the swap arrangement took place in

October 2009, as improved market conditions and increased

minimum prices for participating in the swap scheme made it

cheaper for issuers to return to the public markets. Th e swap

scheme will be fully phased out in September 2014 by the latest,

with around Nkr180bn of covered bonds up for redemption by

then, mostly in 2013 and 2014, according to Blomgren.

Th e phasing out of the swap scheme is likely to take place

smoothly, according to market participants. Barclay’s Harju

says that the central bank is addressing refi nancing risk stem-

ming from the end of swap periods by introducing early ter-

mination options for participants to entice them to exit the

scheme gradually.

“So far there seems to be rather good take-up of this option,” he

says. “We don’t expect a massive avalanche of supply to come along.”

SEB’s Blomgren expects that most of the covered bonds

coming up for redemption under the swap arrangement will be

refi nanced in covered bonds, with the focus mainly on the do-

mestic market, which will be able to absorb the supply. She also

expects a shift away from fl oating rate covered bonds — which

represent 60% of the total outstanding stock due to the format

being eligible for the Norges Bank swap scheme — to fi xed rate

issuance, a development also noted in the Norges Bank Eco-

nomic Bulletin report.

The central bank noted that, according to market partici-

pants, it has been difficult to issue floating rate Norwegian

krone covered bonds with a maturity longer than five years,

with key investor groups such as pension funds and life in-

surers preferring to invest in bonds with long maturities and

fixed coupons.

“Th is may mean that issues of fi xed rate NOK denominated

OMFs will become more common in the future,” it said.

Larger Norwegian issuers may also turn to the international

market to refi nance covered bonds maturing under the swap

scheme, according to market participants. Th e Norges Bank re-

port said that a “substantial proportion” of the covered bonds

used in the swap arrangement are expected to be refi nanced in

a foreign currency, with Blomgren and Fiskerstand also saying

they expect bigger issuers to tap the foreign markets.

Market participants say the outlook for the domestic Norwe-

gian covered bond market is good, supported by increased de-

mand triggered by discussions about making senior unsecured

debtholders shoulder part of the cost of rescuing distressed

banks, and a decision by Norway’s central bank to no longer

accept senior unsecured bank debt as collateral for repo from

February 2012, with covered bonds remaining eligible.

Liquidity improvement plansAlso relevant to the future of Norwegian krone covered bonds

is how they will be treated under liquidity buff er rules in the

Capital Requirements Directive (CRD) IV, which will imple-

ment Basel III regulations. Although outside the European Un-

ion, Norway, as a member of the European Economic Area, is

obliged to implement all fi nancial directives and regulations in

line with implementation in EU member states.

Under CRD IV proposals released by the European Com-

mission in July, the European Banking Authority (EBA) will

have fi nal say over which asset classes will be eligible as level

one assets —facing no limits or haircuts — and level two assets

— which will only be able to comprise up to 40% of a bank’s

liquidity buff er and face haircuts of at least 15%.

Th e decision is particularly important given the low volumes

in Norway of government debt, which under the Basel Com-

mittee’s framework are the main level one liquid asset. Indeed,

Finance Norway (FNO), a Norwegian banking association, in

autumn 2010 put its name to a proposal drawn up by Danish

and German banking associations that would remove a cap on

covered bonds in liquidity buff ers and lower haircuts for some

Jussi Harju, Barclays Capital: “There isa pretty low chance of the parent bank

walking away”

“Issues of fi xed rate NOK de-nominated OMFs will become more common in the future”


NORWAY: SAFE HAVEN

parts of the asset class.

However, the Norwegian central bank has discussed the pos-

sibility that Norwegian covered bonds might not even qualify as

level two assets.

“For Norwegian OMF covered bonds to be included as Level

2 assets, the Norwegian covered bond market needs to become

more liquid,” said Norges Bank in a Financial Stability Report in

May. “Measures by both market participants and the authorities

can help to bring this about.”

Th e Norwegian Covered Bond Council is very focussed on

improving liquidity in the domestic market, according to Helge

Stray, chairman of the council and director, rating and funding,

at DnB Nor Boligkreditt.

“Discussions are somewhat premature, but the fi rst step is to

obtain a more liquid market, more Norwegian krone issuance,”

he says. “Both Norwegian krone domestic issuance and second-

ary trading in NOK covered bonds have increased signifi cantly

in the last year, but there is still room for further growth.

“A second step would be to discuss market-making agree-

ments, etc, but for the moment we are waiting for volumes to

increase further.”

Other measures identifi ed in the Norges Bank report as po-

tentially contributing to greater liquidity include issuers seek-

ing to increase the volume of individual bonds, and the relevant

authorities repealing a regulation (Issue Regulation) that the

report describes as placing certain limitations on the issuance

of bonds at a discount.

“When market rates rise, this may prevent issuers from ex-

tending existing bond series, preventing the bond issuers from

becoming large enough to be attractive for trading in the sec-

ondary market,” it said.

While any improvements in liquidity may contribute to a

more favourable assessment of Norwegian krone covered bonds

by the EBA in its work on liquid assets, the Norges Bank report

also refers to Basel III regulations proposing alternative treat-

ment for fi nancial institutions in jurisdictions with an insuffi -

cient supply of liquid assets in their domestic currency.

“It is reasonable to assume that Norway will be eligible for

alternative treatment,” it said, pointing out that outstanding

government securities, excluding the amount of T-bills in the

swap arrangement, stood at around 14% of GDP in 2010.

Julia Hoggett, Bank of America Merrill Lynch: “The performance of Norwegianmortgage assets is very good”

Norway’s spread performance versus peers

Source: UniCredit

0

50

100

150

200

250

Sep 10 Dec 10 Mar 11 Jun 11 Sep 11

bp

iBoxx € France Covered Structured iBoxx € Netherlands CoverediBoxx € UK Covered iBoxx € France Covered LegaliBoxx € Hypothekenpfandbriefe iBoxx € Norway CoverediBoxx € Oeffentliche Pfandbriefe iBoxx € Sweden CoverediBoxx € Italy Covered


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www.coveredbondreport.com March 2011

To the lifeboats!

Can covered bonds offer safetyafter bail-in panic?

AustraliaA whole new ball game

SterlingUK gains home advantage

US legislationThe FDIC rears its head


The Covered Bond Report is not only a magazine, but also a website providing news, analysis and data on the market.



SMEs bridge Turkish gap

A Turkish covered bond law has taken four years to bear fruit — but SME loans backing the first deal have led to questions over whether it belongs to the asset class. A recent amendment to Turkey’s frame-work should help overcome more tangible challenges and ease take-

up by the country’s banks as their balance sheets expand rapidly. Maiya Keidan reports.



Turkey rolled out covered bond legislation four

years ago, but those awaiting a first issue have had

to be patient, with the debut Turkish covered bond

not having been launched until this July. However,

they might not have to wait long for a second.

Şekerbank inaugurated the asset class by selling covered

bonds totalling around $125m equivalent to three interna-

tional investors. The bank aims to follow this up with a sec-

ond tranche of issuance in the autumn off a TL800m ($473m/

Eu327m) programme.

Ali Küçükcan, vice president in the financial institutions

department at Şekerbank, says that the bank plans to sell a sec-

ond issue, of around TL400m, comprising around three to four

series, in September or October, and aims to place that trade

with more international financial institutions. Separate series

of bonds will be again issued for each investor under the main

programme structure, he says.

The first trade went as expected, says Küçükcan.

“It was parallel to our plans,” he says. “We are happy to sign

the issuance for the first tranche as planned.”

Three investors bought the first series — arranger UniCredit,

the International Finance Corporation, and Dutch develop-

ment agency FMO. The bonds were priced at between 200bp

and 250bp over Libor/Euribor and the maturity varied from

one to five years, depending on the investor.

David Barwise, partner at White & Case, says one of the

reasons why it took so long for a first Turkish covered bond

to come to market was the question of how to deal with cur-

rency exposure.

“International investors like to be paid in euros or dollars,”

he says. “Obviously, a Turkish lira denominated transaction was

not going to appeal to everyone.

“Şekerbank was the first issuer to market for this type of is-

suance, so other banks now have a precedent as to how particu-

lar things are done,” he adds.

Moody’s assigned the covered bonds a rating of A3, which

Şekerbank’s Küçükcan says is the highest rating awarded any

structured transaction from Turkey.

With its debut, Şekerbank took advantage of a near four year

old law that provides for two separate regulations, one for asset

backed covered bonds (ACBs) and one for mortgage covered

bonds. Şekerbank’s programme falls into the asset backed category.

But is it a covered bond?While Şekerbank’s deal showed that asset backed covered bonds

are viable, it prompted some market participants to call into

question whether the debt instrument deserved to belong to the

covered bond asset class.

The first aspect of the covered bond that was called into

question was the cover pool, which comprises loans to small

and medium sized enterprises.

“Any small and medium sized enterprise loan backed cov-

ered bond is not a traditional covered bond,” says a covered

bond analyst. “Traditional assets are mortgages, public sector

loans, maybe shipping, but not small and medium sized loans.

“I’m not sure that’s a covered bond.”

Leef Dierks, head of covered bond strategy at Morgan

Stanley, also says that there have been doubts over the categori-

sation of Şekerbank’s deal as a covered bond.

“The market purists would definitely say it is not a covered

bond,” he says. “The collateral pool is not what the typical cov-

ered bond investor sees as attractive.”

However, José de León, senior vice president at Moody’s,

says Şekerbank’s issue was easily identifiable as a covered bond.

“It was very easy to define,” he says. “The notes issued by the

bank are on balance sheet, they have full recourse to the issuer,

and they are secured by a pool of SME loans.”

De León says that he has had trouble understanding why the

deal’s status has been called into question, particularly given

that the deal is governed by the Turkish covered bond law.

“Şekerbank decided, because they wanted to refinance their

SME loan portfolio, to use the law that is in place for asset cov-

ered loans,” he says. “In most jurisdictions you have only two

possibilities — either mortgage loans or public sector loans —

backing your covered bonds, so it’s good for Şekerbank that it

has another opportunity to refinance its portfolio.”

Despite the ongoing debate over whether the traditional

covered bond label should be applied, market participants were

positive about the Turkish development.

“From what I can tell, this is a very encouraging sign,” says

Dierks at Morgan Stanley. “What I like is that we see an ongo-

ing shift toward newer legislation in places like Canada, New

Zealand and Turkey.

“It’s clear the Turkish covered bonds do not compete with

the Pfandbrief, but you still get a sense that covered bonds are

gaining ground around the world.”

Tweak lifts funding promiseAnd — like them or not — more ACBs could be on their way

due to recent amendments to the Turkish covered bond frame-

work that have eased the way for Turkish issuers. According to

Turkish law firm Eryürekli Law Office, the amendment, pub-

lished in the government’s official gazette dated July 20, has di-

versified the potential issuer base for ACBs and brought in new

investor protection measures.

A specialist at the Capital Markets Board (CMB) of Turkey,

Eser Şagar, is positive that the amendment could help the mar-

ket develop further.

“I think interest in covered bonds is not dependent on the re-

cent amendment,” he says, “though it has dealt with some of the

problems that hindered the growth of covered bond issuance.

“It has mainly made issuance clearer, so it may have a posi-

tive effect — but the main factors driving issuance are the state

of the economy and interest rates.”

“The market purists would definitely say it is not a

covered bond”



Şagar says that the CMB has heard via advisory fi rms of fur-

ther interest in the issuance of asset covered bonds. However,

there have not yet been further applications to issue.

Rapid growth in Turkey’s banking system might suggest that

the country’s banks would be keen to develop the new funding

source. In the fi rst six months of this year alone lending by Tur-

key’s banks grew by 18%, according to data from the country’s

Banking Regulation & Supervsion Agency (BDDK) (see chart).

And when the amendments to Turkey’s legislation were

published, Moody’s commended them for helping to diversify

banks’ funding sources.

“As issuance of covered bonds in Turkey is in its infancy, the

legal amendments are a favourable development for the bank-

ing system’s funding profi le, which consists primarily of short

term deposits,” it said.

Moody’s noted that these deposits, which account for 56%

of balance sheets and with 85% maturing within three months

as of the fi rst half of 2011, constrain the development of longer

term loans and their aff ordability.

“Further diversifi cation into longer term funding sources

will reduce the maturity mismatch between short term liabili-

ties and long term assets,” said the rating agency. “Additionally,

the reliance of covered bonds on on-balance sheet assets, for

which credit risk remains with the issuing bank, encourages the

banks to maintain sound risk management and lending prac-

tices as banks grow their loan books.”

Moody’s said that the amendments are credit positive because

they raise minimum overcollateralisation levels and mitigate com-

mingling risk and a risk of servicing disruptions. Under the new

rules, the minimum overcollateralisation was raised from a statu-

tory obligation of 2% to 8%-46%, depending on the asset class.

Wasif Kazi: “Changes have clarifi ed a few issues thatwere not in the original legislation”

Key aspects of the CMB amendment:

ties that may issue ACBs and thus, have obtained an additional funding option for their activities. In line with the above, receivables arising from all type

er assets for ACB offerings conducted by factoring companies.

ited in the name of the investors with a separate bank account in case the issuer violates cover matching principles or fails to fulfi ll its obligations arising from ACBs. The principle stating that the net present value ( the “NPV”) of cover assets must at all times be at least 2% more than the NPV of the ACBs has been revised

ference between the NPVs of cover assets and of the

centages where it deems necessary and thus create

conditions.

cash derived from the redemption of cover assets, provided that the redeemed assets are replaced with new assets, cover matching principles are in no way

ligations arising from ACBs.

process (i.e. an accelerated and cost effi cient way of

issuer fails to fulfi ll its obligations on due date, (ii) the

er’s assets, (iii) the management control of the issuer

tion license of the issuer is revoked, or (v) the issuer is suffering from bankruptcy.

sions, have attributed new responsibilities to the cover monitor (i.e. independent audit company) which shall be appointed for the supervision of the cover register and cover pool.

Source: Eryürekli Law Offi ce

“Issuance of covered bonds in Turkey is in its infancy”



“Th e new rule mitigates the risks that overcollateralisation lev-

els will decline without remedy and that the issuer commingles

the covered assets’ cashfl ows with its other assets,” said Moody’s.

(See box for a fuller list of amendments.)

Wasif Kazi, director, structured capital markets at UniCred-

it, says the amendment had clarifi ed several issues that arose

during Şekerbank’s transaction. UniCredit was arranger and an

investor in the issue.

“One of the changes, which is helpful in the amended legis-

lation, is that it clarifi es that the CMB would have the right to

appoint a servicer specifi cally for the asset pool in the event of

issuer bankruptcy,” he says, “which should be helpful with the

rating of future covered bonds.

“We did have a long dialogue with the CMB and these

changes have clarifi ed a few issues that were not in the original

legislation.”

While mortgage lending in Turkey has grown strongly, an is-

suer has yet to launch a mortgage backed covered bond. Şagar,

suggests that while mortgage covered bonds are more in line with

traditional standards, they may be harder to issue than ACBs.

“Th e mortgage backed covered bond legislation is much

stricter,” he says. “I think the issuers have to create strict portfo-

lios and that will take time.”

Batuhan Tufan, vice president of Garanti Bank, welcomed

Şekerbank’s transaction but says his bank will not be following

Şekerbank’s lead anytime soon.

“We’ve been having discussions for a very long time,” he

says. “We know the product very well and the feedback we’ve

learned from the market is that investors would still price a

Turkish covered bond wide of the Turkish sovereign.

“Garanti has had several preparations internally but the ulti-

mate conclusion is — given the uncertainty of the ratings, lack

of local investor demand, proper commercial investor demand,

and the uncertainty in the fi nancing cost — we will probably

keep this project running in the background but we will not be

taking action sometime soon.”

Tufan says he knows of other banks preparing for covered

bond issuance behind the scenes, but questioned whether they

could come to the market.

“I think banks will still choose to go on the unsecured fi nanc-

ing market before actually looking at the covered bond space.

Other market participants were more positive about the po-

tential for further issuance.

Asked whether he believed more issuance would be forth-

coming, Fazel Ahmed, managing director, structured capital

markets at UniCredit, replies: “An emphatic yes.”

He does not expect Şekerbank to be a one-off , with other

potential issuers also looking into the product.

“Over time,” says Ahmed, “it is likely that the market will

develop a multitude of issuers.”

Ali Küçükcan: “It was parallel to our plans”

0

100,000

200,000

300,000

400,000

500,000

600,000

700,000

Jan-

03

May

-03

Sep-

03

Jan-

04

May

-04

Sep-

04

Jan-

05

May

-05

Sep-

05

Jan-

06

May

-06

Sep-

06

Jan-

07

May

-07

Sep-

07

Jan-

08

May

-08

Sep-

08

Jan-

09

May

-09

Sep-

09

Jan-

10

May

-10

Sep-

10

Jan-

11

May

-11

Turkish lira (million)

Turkish banks’ loan growth

Source: Banking Regulation & Supervision Agency (BDDK)


ANALYSE THIS: DENMARK

Hans Christian Andersen reading The Ugly Duckling in New York’s Central Park



Over the last few months,

there has been an aw-

ful lot of negative news

surrounding the Dan-

ish banking sector:

the bail-in discussion aft er the default

of Amagerbanken and Fjordbank Mors;

Standard & Poor’s saying that another

15 Danish banks could default; Moody’s

downgrades of several Danish banks

and its tougher stance on refi nancing

margins; concerns about the state of the

Danish economy and the stability of its

housing market; plus regulatory con-

cerns. Th e latter point includes questions

about the eligibility of Danish covered

bonds under CRD IV if house prices fall,

as well as issues surrounding the high

share of adjustable rate mortgages, which

would become problematic under new

Basel III liquidity rules. To make things

worse, investors are concerned about the

periphery exposure of issuers such as

Danske Bank.

Does this mean investors should avoid

Danish covered bonds at all costs?

Given the list of problems, there is no

doubt that investors need to be cautious,

but we think that the market is probably

too negative on the sector, painting a

doomsday scenario for Denmark.

Investors should take into account

that the Danish banks benefi t from ex-

ceptionally strong domestic demand

and a unique mortgage market model.

Th e government has approved the new

Bank Package IV, which will off er alter-

natives to the infamous haircuts of senior

unsecured debt when a bank becomes

insolvent. Moreover, the Danish regula-

tor has made clear that under its insol-

vency rules, secured investors, including

covered bonds and junior covered bond-

holders, would not be subject to any reg-

ulatory writedowns. And even Moody’s

has recently reiterated that Denmark

continues to have “one of the strongest

covered bond frameworks in Europe”.

A brief historyTh e Danish covered bond market is one

of the largest in Europe, second only to

the huge (but shrinking) German Pfand-

brief market. Th e origins of Danish cov-

ered bonds date back to the Copenha-

gen Fire of 1795. Th e total outstanding

amount is around Eu340bn equivalent.

Th e vast majority of Danish covered

bonds are denominated in Danish kro-

ner and only a small portion is issued in

other currencies.

Until the implementation of the Dan-

ish Act of 2007, only mortgage banks were

allowed to issue mortgage bonds/covered

bonds. Th e new law was designed with

the twin objective of enabling commer-

cial banks to issue covered bonds to fund

mortgage loans and ensuring that all Dan-

ish banks could issue bonds that fulfi l the

requirements of the new EU Capital Re-

quirement Directive (CRD). Due to these

regulatory changes, there are now three

diff erent types of mortgage bonds in Den-

mark: RO, SDRO and SDO (see table 1).

Bail-ins and rating pressureOne of the main reasons for negative in-

vestor sentiment towards Danish banks

has been a much discussed new bank res-

olution scheme in Denmark also known

as “Bank Package III”.

Has the market got Denmark wrong?A tough Danish stance on bail-ins in the midst of a banking crisis has had unintended consequences for Denmark’s covered bond issuers. But RBS

senior analyst Frank Will argues that the doomsday scenario some market participants are painting is overdone — as long as the Danes can rise to

the challenge.

“One of the strongest covered bond

frameworks in Europe”



The Bank Package III came into

force in September 2010 when a full

guarantee on Danish bank deposits and

senior debt expired. Since then, “at the

point of insolvency” a bank can decide

to use either a new Orderly Liquida-

tion Framework or existing legal frame-

work for insolvency. If the ailing bank

chooses to use the Orderly Liquidation

Framework, then assets and liabilities

are transferred to Finansiel Stabilitet,

a subsidiary of the Financial Stability

Company. Senior unsecured investors

and depositors (beyond a Dkr750,000

threshold) could then become subject to

debt writedowns.

Importantly, mortgage and covered

bond investors are explicitly excluded

from such debt haircuts.

In February 2011, Amagerbanken was

the first bank to use the Orderly Liquida-

tion Framework. The senior unsecured

debt holders and depositors (beyond the

Dkr750,000 threshold) of the small Dan-

ish lender suffered a 41% write-down. In

June 2011, Fjordbank Mors became the

second Danish bank to choose the “bail-

in” framework rather than use the insol-

vency law. Senior unsecured creditors

and unguaranteed deposits were subject

to a 26% haircut. In both cases covered

bond and mortgage bond investors were

not impacted.

The rating agencies responded by

reducing their government support as-

sumptions for Danish banks.

In May 2011, Moody’s downgraded

six Danish banks, citing a reduced ex-

pectation of systemic support in the af-

termath of the default of Amagerbanken

and the subsequent losses for senior un-

secured investors. The systemic uplift for

the smaller banks was removed, whilst

the rating uplift for larger players such as

Danske Bank, Jyske Bank and Sydbank

was reduced to one notch.

Moody’s also increased refinancing

margins and lowered the timely pay-

ment indicator (TPI) from “very high”

to “high” for many Danish covered bond

programmes. In addition, the agency

took negative rating actions on covered

bonds issued by two Danish banks and

withdrew the ratings on one programme.

Nykredit Realkredit’s Capital Centre D was

downgraded and three of BRFkredit’s pro-

grammes were placed on review for down-

grade. Moody’s also withdrew its rating on

Realkredit Denmark’s covered bonds.

At the end of August, the govern-

ment announced that it will identify

those Danish banks that are of systemic

importance. The list should, in our view,

include at least Danske Bank, Nykredit,

Jyske Bank and Sydbank. Moody’s has

already stated that this will not change

its view on the likelihood of systemic

support, but the announcement should

have a positive effect on the standalone

strength of systemically important banks.

Government backs downAt the end of July, S&P stated that it is

gradually becoming apprehensive about

the riskiness of Danish banks. In S&P’s

opinion, Denmark’s banking crisis is not

over yet and around 15 banks could de-

fault, due to boom year loans made to

the commercial property and farm sec-

tors. Since the financial crisis started in

2008, 11 banks have already defaulted.

S&P believes that the gross losses due

to additional bankruptcies of Danish

banks could reach up to Dkr12bn (c.

Eu1.6bn) over a three year period. While

the number of banks at risk looks scary,

S&P’s estimate of potential losses under-

lines that only tiny banks are at risk.

However, S&P made it clear that it

would reassess its ratings on individual

Danish banks if the losses are larger than

expected. All Danish banks currently

rated by S&P are regarded by the agency

to be systemically important. S&P ex-

pects that those banks may therefore

“receive extraordinary government sup-

port, beyond that defined in the coun-

try’s established bank resolution scheme”.

Here, we agree with S&P and believe that

large players such as Danske Bank and

Nykredit would be treated differently to

the likes of Amagerbanken and Fjord-

bank Mors.

In response to the concerns of both

investors and rating agencies, the Danish

government has somewhat softened its

previous tough stance and set up a new

Bank Package IV. The package has been

agreed by the major political parties in

Denmark but awaits passage into law,

which is not envisaged before a general

election on 15 September.

Key features of the package include

the possibility of stronger banks taking

over ailing banks, thereby avoiding writ-

edowns of senior debt and unguaranteed

deposits, as seen in the cases of Amager-

banken and Fjordbank Mors. The gov-

ernment would support such mergers

by allowing: (i) the replacement of sen-

ior unsecured debt by up to Dkr10bn of

new government guaranteed debt; ii) an

extension of up to three years of up to

“In S&P’s opinion, Denmark’s banking crisis is not over yet”

TABLE 1: COVERED BOND TYPES IN DENMARK

Instrument Description UCITS Compliant? CRD compliant?

RO (Realkredit-obligationer) The traditional mortgage bonds issued by mortgage banks Yes No

SDRO (Saerligt Daekkede Realkreditobligationer)

Covered mortgage bonds issued by mortgage banks, fulfilling the former as well as the new legal requirements

Yes Yes

SDO (Saerligt Daekkede Obligationer)

The new covered bonds issued by commercial or mortgage banks

Yes Yes

Source: Nykredit, RBS

Note: In addition, all ROs issued before 1 January 2008 maintain their covered bond status in accordance with the grandfathering option under the CRD. The new legislation also allows for joint funding, i.e. two or more institutions can jointly issue covered bonds in order to achieve larger issues.



Dkr40bn of existing government guaran-

teed debt; and (iii) the split of an ailing

bank into a good and a bad bank. In such

a scenario, the Danish government might

take over the bad bank to avoid haircuts

for senior debt holders and unguaranteed

deposits.

Th e package is a partial retreat by the

Danish government aft er it realised that

previous regulation was too tough and

signifi cantly increased the funding costs

of Danish banks in the international

capital markets. Moody’s responded by

saying that it views the new Danish Bank

Package IV as credit positive for Danish

banks.

Adjustable rate mortgage challengeTraditionally, the Danish mortgage

market has consisted of 30 year callable

fi xed rate annuity bonds. Over the last

few years, Adjustable Rate Mortgages

(ARMs) have signifi cantly gained in im-

portance and now represent a large pro-

portion of the market. In Denmark, the

underlying interest rate of an ARM is

typically reset every year through the is-

suance of new bonds (usually through a

large auction in December).

Based on fi gures from the Danish

central bank, the outstanding volume of

bonds for fi nancing ARM loans more

than doubled between 2008 and 2011

from Dkr636bn to Dkr1,217bn. In its

recent Financial Stability Report 2011,

the Danish central bank highlighted the

challenge ARM loans represent for mort-

gage banks given that these instruments

fund long term loans by way of short

term bonds.

The upcoming “one year liquidity

rule” of the Net Stable Funding Ratio

(NSFR) will target this very type of re-

financing risk and will require banks

issuing such bonds to hold an amount

equivalent to 65% of a loan until the

customer’s loan is refinanced. Even

though the new rules will have gener-

ous phase-in periods — the NSFR is not

due to be implemented before 2018 —

the Danish central bank recommended

that already “the mortgage credit insti-

tutes should seek inspiration in the new

requirements and move towards more

stable funding”.

Th e Danish banks argue that Danish

ARMs are not comparable to variable

rate housing loans in other European

countries. Danish ARMs benefi t from

the balance principle, which means that

there is a match between loans on the

one hand and bonds funding the loans

on the other. As the interest rate of ARMs

is reset typically every year, the balance

principle ensures that interest rate hikes

are directly passed on to borrowers when

loans are refi nanced, thereby removing

any liquidity risk from the banks.

However, the rating agencies are con-

cerned about the mismatch between the

underlying loan term and the term of the

covered bond refi nancing the loan that

results in refi nancing risk, and increased

reliance of the issuers on regular market

access to issue covered bonds given the

fast growing volume of ARM loans.

In order to reduce this refi nancing

risk, Nykredit Realkredit, in particular,

has spread its refi nancing over the year

so that much of it now takes now place

at other times than in December, but

other mortgage banks have done so only

to a limited extent. However, as high-

lighted by the Danish central bank in its

Financial Stability Report, spreading the

Frank Will: “The market is probably too negative on the sector”



refinancing requirement evenly over the

year is not sufficient to resolve the refi-

nancing issue.

JCBs need a track recordAnother issue for Danish banks are

CRD requirements. Banks issuing cov-

ered bonds (SDOs and SDROs) have

to fulfil the minimum requirements of

the CRD on an ongoing basis. If house

prices fall, the value of the collateral

deteriorates and the loan-to-value ratio

of some mortgage loans may exceed the

80% threshold. In that case, the credit

institutes might have to issue new debt

in form of junior covered bonds (JCBs)

to finance the top-up collateral.

Based on a sample of mortgage loans

and house values of Danish households,

the Danish central bank estimates that

the aggregate need for top-up collat-

eral would be more than Dkr100bn if

house prices fell by 10%. These figures

are considerably higher than in 2008.

However, so far only Nykredit has is-

sued junior covered bonds and initial

demand for such bonds has been luke-

warm. The central bank recommends

that the mortgage credit institutes hold

sufficient buffers by selling JCBs in ad-

vance, by reducing the mortgaging ratio,

or by restricting access to deferred am-

ortisation.

Economy, housing face slow recoveryThe difficult economic situation in Den-

mark, as well as the state of the housing

market, are not providing any relief from

the aforementioned problems, but are in-

stead further fuelling investor concerns.

The Danish economy was in recession

in 2008 and 2009, but started to recover

in 2010. However, quarter-on-quarter

growth was again anaemic in Q4 10 and

Q1 11 (see chart 1). Growth in Q2 11 was

better than expected, at 1.0% quarter-on-

quarter, indicating that there might be

some light at the end of the tunnel. But

it takes more than one swallow to make

a summer and the market will doubtless

monitor closely further economic devel-

opments in Denmark.

Following boom years in 2005 and

2006, Danish house prices fell signifi-

cantly over the three year period from

2007 to 2009. Housing market sentiment

improved in 2010, with positive house

price growth, but has cooled down again

this year. According to the Association of

Danish Mortgage Banks (Realkreditrå-

det), house prices receded towards the

end of 2010 in all regions except the

capital, but the uncertainty has now also

spread to the Greater Copenhagen area.

In Q1 2011, house prices declined by

1.9% quarter-on-quarter at national level

and 1.8% in the capital (see chart 2).

The housing market in Denmark cur-

rently faces an unholy combination of

falling prices, record large supply, and

relatively long times-on-market. Accord-

ing to the mortgage association, detached

and terraced houses sold in the first quar-

ter of 2011 had typically been for sale for

nearly seven months, while the time-

on-market was six months for owner

occupied flats and nearly 11 months for

holiday homes. Detached and terraced

houses were sold at a 11% discount on the

initial asking price. For an average house

of 140 square metres, this corresponds to

a price reduction of around Dkr200,000.

The price reductions for owner occupied

flats and holiday homes were 8.5% and

15%, respectively.

Given the lacklustre economic out-

look for Denmark and the rest of Europe,

a quick recovery of the housing market in

Denmark appears quite unlikely.

Euro spread performance mixedSo far, only Danske Bank has issued euro

denominated covered bonds in bench-

mark size. Danske Bank’s euro bench-

mark covered bonds (SDOs) are backed

by Norwegian or Swedish mortgage as-

sets and are issued either out of Cover

Pool I — which includes only residen-

tial mortgage loans — or out of Cover

Source: RBS, Bloomberg

Chart 1: Danish GDP growth

-8

-6

-4

-2

0

2

4

6

Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11

GD

P gr

owth

in %

GDP growth qoq GDP growth yoy

Source: Realkreditrådet

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

Q1 04 Q1 05 Q1 06 Q1 07 Q1 08 Q1 09 Q1 10 Q1 11

Hou

se p

rice

infla

tion

(%)

Houses (Denmark) Flats (Denmark) Houses (Copenhagen) Flats (Copenhagen)

Chart 2: Annual growth rate in Danish housing market



Pool C — which is a combined pool of

residential and commercial real estate as-

sets. Danske Bank can also issue covered

bonds backed by Danish residential loans

(Cover Pool D). Moreover, its Finn-

ish arm, Sampo, issues covered bonds

backed by Finnish mortgages.

At the beginning of this year, RBS’s five

year Danish euro covered bond index was

trading slightly inside of those of Sweden

and Norway. Since then Danish covered

bonds have cheapened a bit and now trade

wider than their Scandinavian peers.

However, the widening of covered

bonds has been far less severe than the

movements in CDS spreads. Danske

Bank’s five year CDS spreads more than

doubled from around 110bp in April

to 230bp at the beginning of Septem-

ber, reflecting increased concerns in the

market. Moreover, over the last couple

of months, Danish covered bonds have

clearly outperformed French covered

bonds (see chart 3).

We remain cautious regarding the fu-

ture secondary market performance of

Danish covered bonds and believe that the

market would require a decent new issue

premium from any Danish issuer wishing

to come to market. Turnover in Danish

covered bonds has historically been low,

reflecting the high share of buy-and-hold

investors. This means that even limited

selling from investors switching in to new

issues could trigger a considerable widen-

ing of secondary market spreads.

Danish banks must tackle headwindsThe Danish banking sector faces an up-

hill struggle and is under a lot of domes-

tic and international regulatory pressure.

Market sentiment towards Danish banks

remains very negative as highlighted by

the wide CDS spreads. The recent rating

actions and comments from S&P and

Moody’s added fuel to this fire. We re-

main cautious and see risks that covered

bond spreads will widen further.

However, the Danish government has

softened its harsh stance regarding hair-

cuts for senior unsecured investors in a

wind-down scenario and is now trying

to support the banking sector. Danish

banks and their regulators are lobbying

hard with the EU authorities to ensure

that upcoming liquidity rules and CRD

IV will take into account the unique

character of the Danish mortgage mar-

ket. Issuers such as Nykredit have already

started to spread the refinancing risk

resulting from the large ARMs auctions

in December more evenly over the year.

Moreover, the NSFR does not need to be

implemented before 2018 giving the issu-

ers some time to adjust to the new world.

But it is also clear that Danish banks

will have to work hard on all these fronts

to regain investor confidence and that the

market will demand evidence that Dan-

ish banks will be able to cope with the

broad range of problems they face.

Note: Sigmund is on holidaySource: RBS

Chart 3: Five year index spread performance of market segments

0

20

40

60

80

100

Jan Feb Mar Apr May Jun Jul Aug Sep

Spre

ad v

s sw

aps

(bp)

Danish CBs Mortgage Pfandbriefe Obligations Foncières French CBs Swedish CBs Norwegian CBs

Table 2: Outstanding euro-denominated Danish covered bonds in benchmark size

Issue Size (€bn) Cover Pool Property Type Geographical Location

DANSKE 3.75% 23/09/2011 1.0 Sampo Residential Finland

DANSKE 4.875% 11/06/2013 1.25 Cover Pool I Residential Sweden/Norway



DANSKE 3.25% 09/03/2016 1.0 Cover Pool C Residential/Commercial Sweden/Norway*






*Note: currently only Sweden

Source: RBS, Danske Bank

Covered bonds?

Highly rated covered bonds backed by mortgages

Average LTV of 60.5%

Match-funded structure

Core capital ratio of 18.6%

Largest mortgage bond issuer in Europe

nykredit.com/ir

Figures as of 17 March 2011

the covered bond report 4

Documents